DreamWorks Animation SKG Distribution Capstone Project

DreamWorks Animation SKG Distribution:
Review and Recommendation

by

Loren K. Maxwell

A Graduate Term Paper Submitted for
Partial Fulfillment of the Requirements of
the Degree of Master of Business Administration

MKTG 781
Dr. Dwyer
University of Cincinnati
April 11, 2012

DreamWorks Animation SKG Distribution

Abstract

DreamWorks Animation’s current distribution agreement with Paramount expires on

December 31, 2012. Primarily at issue is the 8% distribution fee Paramount currently charges

for marketing and distribution services. This study performs an analysis of the film industry,

DreamWorks Animation, and the case details, to include exploring the options of 1) renewing

with Paramount, 2) securing an agreement with another distributor, or 3) pursuing self-

distribution, to reach several conclusions and provide a recommendation.

Absent information concerning actual options DreamWorks Animation is pursuing or has

been offered, the recommendation is for DreamWorks Animation to secure an agreement with a

major distributor and to show a particular interest in securing with Warner Bros., although it is

doubtful an 8% distribution fee can realized again. For less than the 8% distribution fee,

Lionsgate might be considered, but at greater risk. DreamWorks Animation should not pursue

self-distribution.

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TABLE OF CONTENTS

ABSTRACT ii

LIST OF FIGURES vii

LIST OF TABLES vii

INTRODUCTION 1

Statement of the Problem 1

Need for the Study 1

Research Question 2

METHODOLOGY 3

Type of Study 3

Sources Utilized 3

Assumptions 5

Limitations 6

Key Terms 8

INDUSTRY ANALYSIS 12

Conceptual Model of the Film Industry 12

The Film Industry 17

Hollywood Dominance 17

Producers, Distributors, and Exhibitors 18

The Role of the Distributor 18

The Producer and Distributor Relationship 20

The Distributor and Exhibitor Relationship 22

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Sequencing and Windowing 25

Profit Maximizing and Shifts 25

Piracy 32

Customer as Ultimate Arbiter 33

Key Markets 34

Domestic Theatrical Market 34

International Theatrical Market 43

Domestic Post-Theatrical Market 45

International Post-Theatrical Market 48

The Digital Animation Industry 50

Traditional versus Digital Animation 50

Family feature Film Market 52

Digital Animation Studios 52

COMPANY ANALYSIS 58

Overview 58

Revenues 58

Strategy 61

Franchises 61

International Market 63

Portfolio 65

3-D 67

Strengths, Weaknesses, Opportunities, and Threats 67

Strengths 67

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Weaknesses 69

Opportunities 71

Threats 72

CASE ANALYSIS 74

DreamWorks Animation-Paramount Distribution Agreement 74

Terms 74

Distribution Fees 75

Marketing and Distribution Expenses 78

Portfolio Value of DreamWorks Animation 79

Recent Developments 83

Dispute over Distribution Fee 83

Paramount’s Portfolio 84

DreamWorks Animation Exploring Option 86

Analysts Insights 87

Overview of Distribution Options 88

Requirements 88

Options 91

Renew with Paramount 91

Secure an Agreement with a Different Distributor 93

Pursue Self-Distribute 99

Conclusions 102

DreamWorks Animation Must Mitigate Risk from Its Lack of

Diversification 102

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The Number of Potential Distributors is Limited 103

The Bargaining Power for Distribution Fees Has Shifted 103

RECOMMENDATION 105

REFERENCES 106

APPENDICES 121

APPENDIX A-MAJOR AND MINI-MAJOR STUDIOS, 1995-2012 122

APPENDIX B- MAJOR AND MINI-MAJOR STUDIOS, 2009-2011 124

APPENDIX C-DIGITALLY ANIMATED FAMILY FEATURE FILMS 126

APPENDIX D-PERFORMANCE OF DIGITALLY ANIMATED FILMS

COMPARED TO TRADITIONALLY ANIMATED FILMS SINCE 1995 130

APPENDIX E-DREAMWORKS ANIMATION ANNUAL REVENUES BY

FILM 133

APPENDIX F-CONCISE GLOSSARY FOR DREAMWORKS

ANIMATION SKG DISTRIBUTION STUDY 136

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LIST OF FIGURES

Figure Page

1 Simple conceptual model of the film industry showing production, distribution,
and exhibition. 13

2 Simple conceptual model of the film industry with different markets. 14

3 Conceptual model of film industry 15

4 Comparison of Top Tier Digital Animation Studios; Adjusted Worldwide Gross
in Millions against Metascore 55

5 Comparison of Digital Animation Studio Tiers; Adjusted Worldwide Gross in
Millions against Metascore 56

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LIST OF TABLES

Table Page

1 Consumer Price Index, 1995-2012 10

2 Major theatrical exhibition chains 24

3 Shrinking Window Between Theatrical Release and Post-Theatrical Release 27

4 Approximate cost of film viewing per person-hour, 2010 41

5 Comparison of Substitute Products, 1995-2011 42

6 Worldwide Theatrical Gross in Billions, 1995-2011 44

7 Domestic Home Video Gross in Billions, 1999-2010 48

8 European Home Video Gross in Billions, 1999-2010 49

9 Japanese Home Video Gross in Billions, 1999-2010 49

10 Growth of Digitally Animated Films and the Decline of Traditionally Animated
Films, 1995-2012 51

11 Digital Animation Studios 54

12 Digital Animation Film Studios at the Oscars 57

13 DreamWorks Animation DVD Sales, Ranked by of Adjusted Domestic Gross in
Millions of Accounted for DVD Sales, 2007-2012 59

14 Digital Animation Studio DVD Sales, Ranked by of Adjusted Domestic Gross in
Millions of Accounted for DVD Sales, 2007-2012 60

15 DreamWorks Animation Franchise Films, 2006-2012 64

16 Upcoming DreamWorks Animation Releases 66

17 Domestic and Worldwide Growth of 3-D, 2005-2011 67

18 Paramount Theatrical Distribution Fee in Millions Per DreamWorks Animation
Film 76

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19 Estimated DreamWorks Animation Worldwide Revenue in Millions Per Film 77

20 Estimated Paramount Distribution Fee by Film 78

21 Average Production and Marketing Costs in Millions for MPAA Films, 2001-
2007 70

22 Paramount Distributed Films With $100 Million or More Adjusted Domestic
Gross Released Since 2006 81

23 DreamWorks Animation Compared to Paramount Releases in Millions from
2006-2012 82

24 The Weinstein Company’s Top Films in Adjusted Worldwide Theatrical
Revenue in Millions 96

25 Lionsgate Top Films in Adjusted Worldwide Theatrical Revenue in Millions 98

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DREAMWORKS ANIMATION SKG DISTRIBUTION

INTRODUCTION

Statement of the Problem

DreamWorks Animation is the largest animation studio in the world and has released a

total of 23 feature films since 1998 (DreamWorks Animation SKG, 2012b). Beginning in 2006,

DreamWorks Animation films have been distributed by Paramount Pictures, a subsidiary of

Viacom, under an agreement that expires on December 31, 2012 (DreamWorks Animation SKG,

2012b). Although Paramount offered to extend the terms for an additional year, DreamWorks

Animation rejected the offer (Frtiz, 2011a) to explore more favorable distribution options.

Currently, the three most likely scenarios will be to either 1) renew an agreement with

Paramount, 2) secure another studio to distribute DreamWorks Animation films, or 3) pursue

self-distribution.

Need for the Study

The film industry is highly fractured, dynamic, and complex, with distribution holding a

key position between the production and exhibition of films. As competing producers vie for a

share of an increasingly crowded market, a misstep in the distribution of a film can be disastrous.

This is especially true for an independent producer releasing a limited number of films targeted

at a limited audience and with a small film library to balance the risk of losing millions of dollars

in production costs on an underperforming theatrical release. Even a successful release can

realize much less than its full potential if distribution is handled poorly.

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Research Question

This study analyzes the film industry, DreamWorks Animation, and, to the extent

information is available, the specific case of the expiring DreamWorks Animation and

Paramount distribution agreement, and makes a recommendation in favor of one of the three

options DreamWorks Animation is considering.

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METHODOLOGY

Type of Study

This study to determine how DreamWorks Animation should distribute their films is

qualitative using the grounded theory method. This method was chosen because of the lack of

quantitative data and the consideration of intangible benefits and costs of the case.

The industry analysis focuses primarily on 1995 forward, the period starting with the first

theatrical release of a digitally animated feature film, with an increasing emphasis on more

recent years. The company analysis focuses primarily on 2006 forward, the period starting with

DreamWorks Animation’s current agreement with Paramount Pictures for distribution, again

with an increasing emphasis on more recent years. The case analysis focuses primarily on the

agreement between DreamWorks Animation and Paramount and the events surrounding the

potential to either renew the distribution agreement with Paramount, secure another distributor,

or pursue self-distribution, again with an increasing emphasis on more recent years. In all three

analyses, particular weight is given to data that is determined to have a significant impact on the

future of the industry or company. Older data is examined where appropriate.

Sources Utilized

For this study, a variety of books, periodicals, electronic databases, internet websites,

industry reports, press releases, and filings with the U.S. Securities and Exchange Commission

were considered. Topics investigated for this study were the film industry, DreamWorks

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Animation, and the current distribution agreement between DreamWorks Animation and

Paramount.

For the particular workings of the film industry, the most useful sources were the text

books Entertainment industry economics by Vogel (2011) and The business of media distribution

by Ulin (2010). Aside from the film industry, both explored the business of creative industries in

general and should be considered seminal works on the subject. Similarly, The movie business

book, third edition, edited by Squire (2004) was useful for an overview of the film industry,

although some chapters were already dated given the advances in distribution technology in the

period since its publication.

Industry trade organizations, specifically the Motion Picture Association of America

(MPAA), the National Association of Theater Owners (NATO), the Digital Entertainment Group

(DEG), the Digital Entertainment Group-Europe (DEGE), and the International Video Federation

(IVF), were referenced for current numbers on industry economics and current topics in their

respective areas. Also used in the analysis of the film industry were several industry publications

such as The Hollywood Reporter, Deadline, and The Wrap, business publications such as

Business Week, Forbes, and Fortune, general news publications such as USA Today, Los Angeles

Times, and New York Times, and news sites such as CNN. Also, several academic treatments of

the film industry were found, primarily relating to such subjects as the timing of releases and the

structure of contracts between producers and distributors and between distributors and exhibitors.

Finally, Box Office Mojo (www.boxofficemojo.com) and The Numbers (www.the-

numbers.com) were referenced concerning all domestic and international theatrical revenues for

films while Metacritic (www.metacritic.com) and Rotten Tomatoes (www.rottentomatoes.com)

were considered for all critical reviews of films.

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DreamWorks Animation filings with the U.S. Securities and Exchange Commission and

their related earnings conference call transcripts were considered the primary source for all

information concerning DreamWorks Animation as well as any press releases from the company.

Also useful were several investor sites such as Seeking Alpha (www.seekingalpha.com) and

Motley Fool (www.fool.com), as was an exceptional analysis of DreamWorks Animation by

Andrew August (2011) at Frog’s Kiss (www.frogskiss.com).

Concerning the distribution agreement with Paramount, DreamWorks Animation filings

and related earnings conference call transcripts were again considered the primary source for all

information. Additionally, industry publications such as The Hollywood Reporter, Deadline, and

The Wrap proved invaluable when examining the most recent updates, as were various general

news publications, in particular the Los Angeles Times.

Finally, DreamWorks Animation Investor Relations was contracted for additional

information on both the company and the specifics of the agreement with Paramount. The reply,

while polite, referred to the public information available in SEC filings and press releases.

Assumptions

This study makes the assumption all firms are profit maximizing, meaning their decisions

will be consistent with the sole goal of maximizing economic profits (Nicholson and Snyder,

2011). This is assumed to be particularly true of public companies, such as DreamWorks

Animation and Paramount’s parent Viacom. Additionally, for this study, the assumption is

extended to trade associations, such as the Motion Picture Association of America. Although

trade associations are not necessarily directly driven by profits, they seek to advance the business

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interest of their members, which are assumed to be profit maximizing firms. Although in truth

personal and professional relations undoubtedly impact business decisions, this simplifying

assumption effectively excludes from consideration a sizeable volume of salacious information

pertaining to DreamWorks Animation CEO Jeffrey Katzenberg’s relationship with the major

studios, specifically his contentious departure from Disney in 1994 (Borden, 2009), and to

recently reported acrimony toward Brad Grey, chairman and CEO of Paramount (Masters,

2011b).

Additionally, in instances lacking any other information, it was assumed domestic

theatrical revenue would suffice as a measure of success for a particular film, producer,

distributor, or exhibitor. Many sources have noted a strong correlation between the domestic

theatrical market and subsequent markets, although the correlation is to varying degrees and “a

range of other market and film-specific factors . . . can have a significant impact on a film’s

performance in the international theatrical market as well as in the worldwide home

entertainment and television markets” (DreamWorks Animation SKG, 2012).

Limitations

As with any study, limitations due to incomplete or imperfect information are inherent.

Each known limitation is reviewed with a short comment about the mitigation strategy for the

limitation.

Although the sources utilized proved invaluable, unavailable were the undoubtedly

innumerable discussions and arrangements which occurred outside of the attention of the media.

No assumption is made concerning information not reported through the media. Additionally,

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most contemporary sources, especially the trade publications, often report industry rumors which

may or may not surface later as verified fact. For this study, rumors are identified as such and

heavier consideration is given to information reported as fact.

A useful source of information was investment oriented sites, however, it is noted here

that the purpose of investment reporting is to inform actual or potential stock investors on the

value of a particular stock relative to the condition of the market as opposed to an objective

analysis concerning the financial wellbeing of a company. Speculative reporting is the norm as

is the exploration of different scenarios and their perceived impact on a company’s stock price.

In short, investment reporting often centers on a company’s stock as opposed to the company

proper. As a pertinent example, the lack of specific public statements by DreamWorks

Animation concerning their distribution options creates uncertainty in the stock market and thus

impacts the stock price, although this does not necessarily equate to DreamWorks Animation

lacking distribution options and suffering an actual threat to their future revenue. For this study,

all such discussions centering on a company’s stock price were not factored although relevant

information might have been collected and used.

Another limitation in investment reporting is the frequent use of unreferenced estimates,

making it difficult to determine their validity and reliability. This uncertainty in the estimates is

further compounded by the speculative nature of investment reporting. In all such cases, an

effort was made to validate an estimate with an outside source or to use it in conjunction with an

outside source that contained a similar estimate.

Similarly, although DreamWorks Animation’s filings proved to be an exceptional source

of information, it is also noted that its primary purpose is to report to investors rather than be

used for a business analysis. Although the purposes overlap, they are not exactly equivalent. As

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a result, language in filings and associated earning calls is often neutral and purposefully vague

to be mindful of the ramifications on the company’s stock price. The use of these reports and

their associated earnings calls were limited to non-controversial information (i.e., the overview

of the business as provided in Item 1 of the Form 10-K) and for the first source for any

information concerning DreamWorks Animation.

Another limitation is the surprising lack of public data concerning certain relevant

markets, specifically large segments of the international theatrical market, particularly China and

India, and much of the post-theatrical market. Figures for VHS, DVD, and Blu-ray sales and

rentals for specific films are woefully incomplete or unavailable, especially prior to 2006.

Similarly, there seems to be no source for comprehensive data on digital distribution, such as

sales and rentals through iTunes or Netflix. However, as noted above, it is assumed the domestic

theatrical market is well correlated to subsequent markets, albeit to varying degrees

(DreamWorks Animation SKG, 2012b).

Finally, and perhaps most limiting for this particular study, is the lack of information for

actual distribution proposals and options that DreamWorks Animation may be weighing in light

of the imminent expiration of their agreement with Paramount. As a result, the recommendation

of this study is of necessity fairly generic and does not and cannot endorse a particular option

with any specification. If given complete and perfect information, it is quite possible an entirely

different conclusion would have been arrived at other than the recommendation presented.

Key Terms

Several key terms specific to this study are used that warrant the early exploration of their

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definitions to prevent confusion. A concise glossary is provided in Appendix F.

Due to a variety of production methods and occasionally a mixture of production

methods, such as a film combining live and animated elements, for this study a digitally

animated film specifically refers to any film whose Genre is identified as “Animation –

Computer” by Box Office Mojo and excluding any whose Genre is also indentified as

“Animation – Motion Capture” by Box Office Mojo or whose Production Method was identified

as “Animation/Live Action” by The Numbers. A traditionally animated film refers to any film

whose Production Method is listed as “Hand Animation” by The Numbers while a stop motion

animated film refers to any film whose Production Method is listed as “Stop-Motion Animation”

by The Numbers.

Also, the scope of the release can be relevant to distinguish films that are meant to

compete on a national scale. Although some studies consider a film to have a wide release if it

plays on 600 screens concurrently, for this study a feature film refers to any film shown on 2,000

or more screens in domestic theaters as reported by either Box Office Mojo or The Numbers.

Also, films tend to target different audiences, which are often seen in their ratings and the

genre they take place in. For this study, a family film is any film rated “G” or “PG” by the

Motion Picture Association of America and classified in the “Adventure” or “Comedy” Genre by

The Numbers.

This study uses key terms cumulatively, such as discussing digitally animated family

feature films, which have all the above characteristics. All DreamWorks Animation releases are

either digitally animated family feature films, traditionally animated family feature films, or

stop-motion animated family feature films.

Occasionally, the use of inflation adjusted dollar amount is helpful or necessary for

9


comparisons. In such cases, this study will refer to those amounts as adjusted. Adjusted dollars

have been calculated to their 2010 equivalents using the Consumer Price Index from the U.S.

Department of Labor Bureau of Labor Statistic according to Table 1.

Table 1
Consumer Price Index, 1995-2012
Year CPI Year CPI Year CPI
1995 1.4308 2001 1.2319 2007 1.0517
1996 1.3898 2002 1.2121 2008 1.0128
1997 1.3586 2003 1.1851 2009 1.0164
1998 1.3378 2004 1.1543 2010 1.0000
1999 1.3089 2005 1.1165 2011 0.9694
2000 1.2663 2006 1.0816 2012 0.9506

Of note is that this method differs significantly from the method used by the website The

Numbers, which uses the ratio of the average ticket price for different years to perform their

inflation adjusted calculations. For this study, The Numbers method is considered inferior to

using the Consumer Price Index.

Using adjusted dollars for worldwide theatrical revenue, it is possible to reasonably group

animation studios that have exceeded specific thresholds. For this study, a top tier digital

animation studio is any studio that has realized worldwide adjusted theatrical revenue of over $1

billion for digitally animated family feature films. As of April 10, 2012, four studios have met

this criterion: DreamWorks Animation, Disney’s Pixar, Fox’s Blue Sky Studios, and Disney

Animation Studios. A middle tier digital animation studio is any studio that is not a top tier

studio, but has released at least one digitally animated family feature film that realized

worldwide adjusted theatrical revenue of $200 million or higher. As of April 10, 2012, four

studios have met this criterion: Universal’s Illumination Entertainment, Animal Logic, Industrial

Light & Magic, and Sony Pictures ImageWorks. The top tier digital animation studios and

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middle tier digital animation studios are considered the major digital animation studios. Finally,

a bottom tier digital animation studio is any studio that is not a top or middle tier studio, but has

released at least one digitally animated family feature film. As of April 10, 2012, fifteen studios

have met this criterion.

Additionally, the film industry has several tiers of distributors as well. Vogel (2011)

defines a major studio as a company with an important and long standing presence in both

production and distribution with substantial library assets and some studio production facilities.

For this study, a major studio can be quantitatively identified as a distributor who captures 10%

or more of the total adjusted domestic theatrical gross. As of April 10, 2012, there were six

major studios: Disney, Fox, Paramount, Sony, Universal, and Warner Bros. Also, a second tier

of distributors are normally identified as well, commonly referred to as the “mini-majors”. Ulin

(2010) defines a mini-major studio as a company that is independent, can offer broad

distribution, and consistently produces and releases a range of product, but is largely

distinguished from a major by distribution capacity. For this study, a mini-major studio can be

quantitatively identified as a distributor who captures more than 1% but less than 10% of the

total adjusted domestic theatrical gross. As of April 10, 2012, there were two mini-major

studios: Lionsgate and The Weinstein Company, although MGM is identified as a previous mini-

major studio.

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INDUSTRY ANALYSIS

There’s no business like show business – Irving Berlin

Conceptual Model of the Film Industry

Few industries capture the interest of the public like show business. It is commonly

believed to be a mythical realm worthy of the stories it produces, where powerful moguls

execute cutthroat deals and bold Machiavellian maneuvers, where its famous citizens teeter

perilously between luxurious excess and ruinous scandal, and where the small town girl naïvely

believes she is only one wish upon a star from avoiding the boulevard of broken dreams. Any

other industry can seem pedestrian by comparison.

In truth, though, the everyday minutia of the film industry is perhaps much more prosaic

than Hollywood itself might admit. Agreements are settled perhaps more often in conference

rooms and occasionally court rooms by businessmen and lawyers as opposed to in smoky

backrooms by anonymous power brokers and their lackeys.

This is not to say, however, the film industry is the same as the petroleum industry or the

fishing industry. The film industry is one of the creative industries, which are characterized by

several economic properties (Caves, 2000):

- Creative industries are driven by new and unique products and are therefore

subject to highly uncertain demand.

- Creative workers care greatly about what they produce as opposed to workers in

other industries whose labor tends to be primarily functional and standardized.

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- Many creative ventures, such as films and live performances, require workers

with diverse and specialized skills.

- Creative products tend to be differentiated both vertically and horizontally.

- Creative products can differ in many small ways for an infinite variety.

- Many creative ventures require close temporal coordination by all contributing

elements.

- Royalties and rents are often collected in small lump sums over long periods of

time.

In addition to examining the economic properties for a creative industry, the film industry

can be further explored through the development of a conceptual model with three distinct

components as the foundation: production, distribution, and exhibition, as illustrated in Figure 1.

Production refers to all the activities required to produce one copy of a film, while distribution

refers to all the activities related to marketing and delivery of a film to exhibitors, and exhibition

refers to activities performed to permit the consumption of the film (Eliashberg, Elberse, and

Leenders, 2006).

Figure 1 Simple conceptual model of the film industry showing production,
distribution, and exhibition.

The next step in the development of the conceptual model is to consider the two general

markets for theatrical release: the domestic market, which is the United States, Canada, Puerto

Rico, and Guam (“Glossary of movie business terms”, n.d.), and the international market, which

is all markets outside the domestic market (“Glossary of movie business terms”, n.d.). These

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combine to form the worldwide market (“Glossary of movie business terms”, n.d.).

As illustrated in Figure 2, release into the international market can be further segmented,

in this case into the notional regions of Region 1 and Region 2. This segmentation is typically

along national boundaries. Also shown in Figure 2 is the ability of the producer to divide

distribution rights among more than one distributor, in this specific instance using the same

distributor for the domestic market and Region 1 but a different distributor for Region 2. Not

shown is that a producer can also use multiple distributors for the same market if the distribution

rights are parceled out in such a manner.

Figure 2 Simple conceptual model of the film industry with different markets.

In this notional example, Region 1 will begin exhibition slightly after the domestic

market and slightly before Region 2. As well, the film will be exhibited for extended time in

Region 1 as compared to Region 2 and the domestic market. This represents sequencing into the

various markets as well as windowing the length of the exhibition. If no other window overlaps,

as is the case with the first portion of the domestic theatrical release, the exhibiting window is

considered to have exclusivity, from an exhibitor’s standpoint the most desirable characteristic of

any windows (Ulin, 2010).

With the next iteration of the conceptual model in Figure 3, film distribution begins to

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become exponentially more complex with the introduction of post theatrical markets,

particularly with the multitude of exhibition methods available. For simplicity, only two

notional exhibition methods are shown for the post theatrical, but home video (VHS, DVD, and

Blu-ray), pay per view television, cable television, network television, syndication, video-on-

demand, etc., represent but a few of the exhibition methods currently available in a rapidly

growing market.

Figure 3 Conceptual model of film industry

In addition to the relationships and concepts discussed above, the expansion of the

conceptual model introduces a distributor who utilizes another distributor, specifically where the

domestic theatrical distributor uses another distributor to penetrate the Region 1 market for

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Notional Exhibition Method 1. This could be due to any number of reasons, such as the sub-

distributor having familiarity in Region 1 or perhaps familiarity in Notional Exhibition Method 1

or perhaps even exclusive ability to utilize Notional Exhibition Method 1 in Region 1 due to

legal or technological constraints. An example might be cable television with a monopoly in

Region 1.

Also depicted is additional production prior to distribution into Region 1 for Notional

Exhibition Method 2. International markets often require additional production, such as

subtitling or dubbing (Eliashberg, Elberse, and Leenders, 2006) or editing for controversial

content. Given the vast number of international markets and exhibition methods, the number of

versions for a film can easily reach 150 (Ulin, 2010). However, almost any market offers the

potential for additional production, such as special features in DVDs and Blu-rays. In reality,

each market and exhibition method combination would most likely be touched by additional

production beyond the making of a film as would the same market and exhibition method in a

later window, such as releasing an anniversary edition DVD of a film 10 years after it had

already been through a typical sequencing and window cycle. Even within the same market,

exhibition method, and window, a film can benefit from additional production if it can

significantly differentiate the exhibition for the consumer, such as a theatrical release of a film in

both 2-D and 3-D.

Even a casual review of film industry trade publications demonstrates the above

conceptual model is elementary, especially when compared to the overwhelming number of

producers, distributors, and exhibitors, the dizzying number of markets and their individual

nuances, and the manifold and increasing number of exhibition methods cycling through the

various stages of their product life cycle. Proper sequencing and windowing of a film, the key to

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profit maximizing, can become immensely complex with a vast number of competing interests

from producers, distributors, and exhibitors. The key components, relationships, and concepts

illustrated in the conceptual model will be referenced in the remainder of the study.

The Film Industry

Hollywood Dominance

A prerequisite to fully understanding the film industry is the appreciation of the historic

dominance Hollywood-based studios have enjoyed in practically every significant market

(Vogel, 2011). From the beginning, domestic filmmakers held several early advantages over

their European rivals, namely 1) the world’s largest domestic market characterized by a diverse

immigrate culture, 2) a well-developed industrial organization as compared to the largely

artisanal production and distribution systems abroad, and 3) an appealing ideology of optimism

and a practice of producing happy endings in contrast to the often stark and morose fade-outs

common in early foreign films (Trumpbour, 2002). Additionally, this dominance is unlikely to

end soon due to 1) the public good/joint consumption nature of films, where the consumption by

one consumer does not reduce or detract from the consumption by another, 2) the greater

opportunity to amortize films in the post theatrical market across a relatively large population

with a strong breadth and depth of exhibition methods, and 3) a minimized “cultural discount” on

the product through the use of English, the second most popular language in the world and used

by the majority of speakers residing in the wealthiest nations (Vogel, 2011). Other reasons cited

for this dominance include historical happenstance, technological innovation, availability of

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capital, application of marketing prowess, and culture (Vogel, 2011).

Because the United States has long been the dominant exporter of film and television

programming, the net trade balance for these products has been at least $4 billion per year

(Vogel, 2011) with an $11.9 billion surplus in 2009, which accounted for 8% of the total U.S.

private sector trade surplus in services (MPAA, 2011). Interestingly, as with any industry with a

strong trade surplus, the film industry is subject to fluctuations in the strength of the dollar in the

world economy (Aft, 2004). A weak dollar, where revenue collected in foreign currencies

equates to more dollars, can help offset production costs originally incurred in dollars (Aft,

2004). Conversely, a strong dollar tends to hurt the film industry (Aft, 2004).

Producers, Distributors, and Exhibitors

Role of the Distributor

Prior to 1948, the larger companies in the film industry, referred to as studios, generally

controlled all three stages of production, distribution, and exhibition (Fellman, 2004). Under this

system, studios often utilized the real estate value of their theater locations as collateral to

finance the production costs of films (Vogel, 2011). However, in a landmark decision

concerning vertical integration antitrust cases, the studios divested themselves of theater

ownership under a consent decree in U.S. v. Paramount Pictures, Inc., dismantling the old

Hollywood studio system and ushering in the modern era of the film industry (Ulin, 2010).

Now, absent the ability to finance production through theater locations and lacking the ability to

control exhibition, distributors became more selective about the films they risked production

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costs on, in turn becoming the pivotal players that controlled the flow of content to consumers

(Vogel, 2011). In short, the major studios evolved into distribution operations, where buying

intellectual properties, hiring movie stars, and financing films is to some extent simply a pretext

to owning and controlling distribution rights (Ulin, 2010).

Filmmaking as a commercial venture is a highly risky proposition, where most major

films do no better than break even with extreme deviations in both directions (Vogel, 2011) and

the few highly successful films must pay for the many underperforming ones (Vogel, 2011). The

top 20 grossing films in any year will account for around 40% of the year’s revenues and 10% of

the films will generate 50% of the revenue (Vogel, 2011). In terms of profits, the prospect is

even bleaker, where an estimated 5% of films generate 80% of theatrical exhibition profits

(Vogel, 2011). For a studio to be successful, a highly successful film often requires an

approximately 20% return simply to offset losses from other films (Ulin, 2010), not to mention

the many films abandoned during or perpetually stuck in production (Ulin, 2010).

To a large degree, distributors can be properly viewed as managers of a specialize

portfolio consisting of films (Ulin, 2010). A simple application of modern portfolio theory

would drive studios to adjust and mitigate risk exposure through diversification by balancing a

mix of high-, medium-, and low-budget films in their yearly releases (Vogel, 2011). According

to data compiled from The Numbers, the six major studios averaged between around 23 and 42

releases annually from 1995 to 2012. Statistically, more films ensure consistent deviations in

revenue and profits, and therefore temper risk, but it is also noted films graduating through

production are not truly random samples, but rather selected based on their potential for

profitability, stacking the deck considerably in favor of the distributor (Ulin, 2010).

Additionally, films that become unprofitable during production can either be abandoned or

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reprioritized to improve its chances (Ulin, 2010). As a final consideration for distributor

portfolios, film libraries can also be considered as a low risk source of profit (Vogel, 2011),

although their effectiveness can be subject to price erosion (Ulin, 2010).

Major studios have historically accounted for approximately 90% of domestic theatrical

revenue (Vogel, 2011). Using data compiled from the Numbers, Appendix A shows major

studios received 89.4% of the domestic theatrical revenue from 1995 to 2012 although they only

released 35.2% of the films. As perhaps evidence of a growing independent movement made

possible by decreasing production and distribution costs, Appendix B shows major studios only

accounted for 26.7% of film releases from 2009 to 2011. However, they still managed to take in

a disproportionate 85.0% of domestic theatrical revenue.

The Producer and Distributor Relationship

Intuitively, the relationship between producer and distributor seems contentious by

nature. After investing perhaps years of work, millions of dollars, and buckets of sweat equity

into a project over which they most likely enjoyed absolute authority, the great culmination of a

producer’s effort is to essentially hand over a completed film to a distributor just as it is ready for

consumption (Ulin, 2010). This poses significant risk to a producer who wants as many

opportunities as possible to guarantee the success of a film, although, under the portfolio model,

a distributor may be ready to quickly abandon an underperforming film in favor of diverting

marketing and distribution resources to another (Ulin, 2010). Although producers are generally

greatly concerned with the quality of their creative work (Caves, 2000), from the distributor’s

portfolio perspective, producers are little more than efficient sources for developing content for

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the portfolio (Ulin, 2010). As such, the producer’s power in the relationship comes directly from

the film’s distribution rights.

Because a film is intellectual property, and therefore infinitely indivisible, a film’s

copyright owner could parcel off each discreet distribution right to a different distributor (Ulin,

2010). Typically it would benefit the producer to do so in order to reduce or eliminate cross-

collateralization of the revenues, where revenues from one territory are used to offset losses from

another (Blume, 2004). By limiting cross-collateralization, a loss is compartmentalized and does

not impact the potential for revenues in other distribution avenues (Vogel, 2011). This

significantly shifts the risk to the distributor, and as such, distributors are naturally reluctant to

separate these rights unless other arrangements for compensation can be made (Vogel, 2011).

Producer and distributor agreements essentially boil down to the specification of the

allocation of revenue streams, to include specifying distribution fees, ownership rights, and

advertising and marketing commitments, along with details concerning account statement

preparation and audits (Vogel, 2011). Also commonly structured into producer and distributor

agreements is the degree of creative control, which normally serves to mitigate risk on the part of

the distributor, especially if the distributor is serving as a financier for all or part of a film. For

example, a step deal provides funding in steps that allow the financier the ability to advance

additional funds contingent on predetermined conditions (Vogel, 2011). These predetermined

conditions typically involve one of the essential ingredients of a production: screenplay, director,

producer, principle cast, and budget (Vogel, 2011), such as the financier approving the draft of a

screenplay or requiring the producer to secure certain casting choices.

When financing on the part of a distributor is involved, distribution fees are commonly

30% for domestic theatrical release, 40% for international distribution and television syndication,

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and 15% for other distribution avenues (Vogel, 2011). With a high barrier to entry for major

domestic distribution operations (approximately $70 million per year in operating costs in an

industry offering substantial risk), distribution fees are not especially sensitive to bargaining

pressures, although notable exceptions do exist (Vogel, 2011).

For producers who can finance from other sources and essentially deliver a completed

film, distribution fees as low as between 12.5% and 17.5% can be realized (Vogel, 2011). For

example, after the success of Toy Story, Pixar negotiated a seven-year, five-film agreement with

Disney for a 12.5% distribution fee (Burrows, 1998b). Also, although rare, a limited number of

wealthy and powerful producers who can shoulder all the risk and self-financing for a film can

secure even lower distribution fees if the film’s likelihood for success is particularly high (Ulin,

2010). Following the success of Iron Man, Marvel Entertainment negotiated an 8% distribution

fee with Paramount for its Marvel Cinematic Universe franchise of films (Vogel, 2011). George

Lucas was able to negotiate a distribution fee of just 6% with Fox for the second Star Wars

trilogy (Vogel, 2011). Currently, DreamWorks Animation’s agreement with Paramount is for an

8% distribution fee (DreamWorks Animation, 2011).

From the perspective of any particular film, distribution fees may generally be regarded

as profit (Vogel, 2011). However, from a distributor’s portfolio perspective, profit from any

particular film is first used to offset unrecovered distribution costs from other films (Vogel,

2011).

The Distributor and Exhibitor Relationship

The relationship between a distributor and a particular exhibitor depends heavily on

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where the exhibitor sits in the sequencing and windowing of films and where the exhibition

method is at in its product life cycle. Contracts can take a variety of shapes, but terms

necessarily specify the details of the exhibition rights, to include length of the exhibition window

as well as time and territorial exclusivity and perhaps, at least in the case of theatrical exhibition,

conditions such as auditorium size (Vogel, 2011).

Although there are many variations, conventional contracts between distributors and

theatrical exhibitors call for a sliding percentage of the revenue after allowances for the

exhibitor’s expenses, referred to as the “nut”, which consists of items such as rent and utilities

(Vogel, 2011). The nut is negotiated in advanced and is normally higher for theaters with better

locations and larger and newer facilities (Vogel, 2011) and is often understood or assumed to

actually be higher than true theater expenses (Vogel, 2011). In the first week, after the nut is

subtracted, revenues are typically split with 90% going to the distributor and 10 % to the

exhibitor (Vogel, 2011). Generally, every two weeks the split is adjusted in favor of the

exhibitor by 10% (Vogel, 2011).

Over the life of a theatrical exhibition, distributors normally receive about half of revenue

while theaters retain the other half (Vogel, 2011). DreamWorks Animation reports theaters pass

between 49% and 56% of domestic theatrical revenues to Paramount (DreamWorks Animation

SKG, 2012b). Although the amounts are roughly equal over the life of a theatrical release, films

typically experience a strong opening and then fade over time (Ulin, 2011) and the sliding

percentage agreement is structured to allow the distributor the fastest recuperation of distribution

and marketing expenses (Vogel, 2011).

Of note, the most significant source of profit for exhibitors is concession stand sales,

whose profit margins on individual items often exceed 50% and can reach up to 90% on items

23


such as popcorn (Vogel, 2011). In fact, concession sales for some theaters account for 90% of

profit (Vogel, 2011) and are often the difference in in a theater’s economic viability (Lowe,

1983). Historically, revenue from concessions, which can account for approximately a third of

total exhibitor revenues (Vogel, 2011), has been unsuccessfully targeted by producers and

distributors alike, but over time has come to be considered “sacrosanct” for the exhibitor (Ulin,

2010). This reliance on concession revenue drives theater owners to be almost single-mindedly

focused on traffic (Ulin, 2010).

Table 2
Major theatrical exhibition chains
Circuit Screens Sites Average
Regal Entertainment Group 6777 548 12.4
AMC Entertainment. Inc. 5336 378 14.1
Cinemark USA, Inc. 3825 293 13.1
Carmike Cinemas, Inc. 2268 242 9.4
Cineplex Entertainment LP 1347 130 10.4
Rave Motion Pictures 936 62 15.1
Marcus Theatres Corp. 668 54 12.4
Hollywood Theaters 546 49 11.1
National Amusements 450 34 13.2
Harkins Theatres 429 30 14.3
Other 16,651 4,122 4.0
Total 39,233 5,942 6.6
Source: NATO, as of June 24, 2010

Table 2 shows that the top six domestic theater chains control 52.2% of all screens and

27.8% of all theater sites (NATO, 2010), however, due to their tendency to control the best

locations and most modern screens, the top one third of all screens account for an estimated 75%

of domestic theatrical revenue while the top six exhibitors account for at least 80% of the total

domestic theatrical revenue (Vogel, 2011).

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Sequencing and Windowing

Profit Maximizing and Shifts

Distribution is the art of maximizing profit by choreographing exhibition rights through

sequencing and windowing against the challenge of waiting for the consumptive verdict on the

experienced good (Ulin, 2010). The ability to maximize the return on the whole assumes one

distributor enjoys autonomous control of all distribution rights to set sequencing and windows

(Ulin, 2010).

As a general principle, films are normally distributed to the market generating the highest

marginal revenue over the least amount of time and then cascading down in order of marginal

revenue contribution (Vogel, 2011). However, distributors are not necessarily looking to

maximize the revenues for each particular exhibition method, but rather to maximize revenues

overall (Vogel, 2011), so considerations such as the extent to which one exhibition method adds

to the total audience or eliminates consumers from other exhibition methods and the rate of

declining viewer interest are factored (Owen and Wildman, 1992). As an example of one

revenue source diminishing while overall revenues increase, television networks have abandoned

the practice of aggressive bidding for films with the rise of cable television, which tend to pay

more than network television (Vogel, 2011). For the most part, the greatest marginal revenue per

unit time is generated from the theatrical release, which also tends to generate the greatest

amount of interest in subsequent exhibition methods (Vogel, 2011)

As an insight to distribution decisions, Ulin (2010) provides “Ulin’s Rule”, stating:

Content value is optimized by exploiting the factors of 1) time, 2) repeat consumptions, 3)

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exclusivity, and 4) differential pricing in a pattern taking into account external market condition

and the interplay of the factors among each other. An example of the interplay between these

four factors is the standard practice of driving repeat consumption of the same product by

creating exclusive windows for different exhibition methods at differentiated prices (Ulin, 2010).

Ulin (2010) argues Ulin’s Rule allows distributors to maximize the lifetime value of a single

piece of intellectual property.

The standard sequencing by distributors starts with the theatrical release and is followed

by pay-per-view television, packaged media (VHS, DVD, and Blu-ray), video-on-demand, pay

television (premium cable channels), and network television (Ulin, 2010). However, the

increasing variety of exhibition methods creates more competition between exhibition methods

and drives an acceleration and compression of windows (Ulin, 2010). As a result, every segment

becomes fearful of cannibalization of revenues from a different segment and the greatest power

of any window becomes exclusivity, a true rarity aside from the initial theatrical release (Ulin,

2010). Against the pressure to shift windows, distributors become the arbiter between exhibitors

through the control of exhibition rights, including first rights and exclusivity rights (Vogel,

2011). This potentially creates great conflict between distributors and exhibitors since

distributors make sequencing and window decisions centered on maximizing revenue for

distributors vice exhibitors (Vogel, 2011).

Among the pressures on windows is the large amount of capital required to produce and

distribute films. Oversized production budgets, high interest rates, and substantial marketing

costs drive distributors to select sequencing and window strategies to bring the largest return to

the distributor over the shortest amount of time, driving earlier openings of all windows in the

desire for faster recoupment (Vogel, 2011). Specifically, As post theatrical markets such as

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packaged media, pay-per-view, and video-on-demand services are capable of generating higher

marginal revenues over a shorter period of time, distributors can significantly decrease the time

to recoup their investments by reducing the period between release windows between the

theatrical and post theatrical markets (Eliashberg, Elberse, and Leenders, 2006), and continually

did so from 1998 to 2008 as shown in Table 3. This tightening of windows additionally saves

marketing money for the distributor and opens the exhibition earlier to revenue from customers

who would not have gone to the theatrical release anyway (Ulin, 2010). However, these shorter

exhibition windows in theaters has a disproportionate negative impact on theater owners under

the traditional sliding percentage agreement since theaters reap more benefit the longer a film

plays (Ulin, 2010).

Table 3
Shrinking Window Between Theatrical Release and Post-
Theatrical Release
Year Average Time Between Release Windows Days
1998 5 months, 22 days 172
1999 5 months, 18 days 168
2000 5 months, 16 days 166
2001 5 months, 12 days 162
2002 5 months, 8 days 158
2003 4 months, 27 days 147
2004 4 months, 20 days 140
2005 4 months, 18 days 138
2006 4 months, 11 days 131
2007 4 months, 19 days 139
2008 4 months, 10 days 130
Source: NATO memo, December 12, 2008, RE: Average Video
Announcement and Video Release Windows, from Ulin (2010)

Some support an even more aggressive collapsing of windows into the post theatrical

market. Stating distributors are simply not maximizing the profit potential of a film, BTIG

Research analyst Richard Greenfield called for distributors to “permanently collapse windows as

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the new Hollywood business model” (Chacksfield, 2012), asserting distributors should be

pushing the release windows to four weeks instead of four months (Gruenwedel, 2012a),

undoubtedly to the delight of many exhibitors and to the chagrin of many others.

Additionally, the impact of advancing technology on sequencing and windowing cannot

be overstated, particularly advances in distribution and storage, which has lead to the post

theatrical market to eclipse the theatrical market in terms of revenue (Vogel, 2011). In 1986, for

the first time distributors earned more revenue from the post theatrical market than in the

theatrical market and forever changed the fundamental structure and marketing strategies (Vogel,

2011).

No longer restricted to bulky prints and costly projectors, feature films can now be

consumed on televisions, computers, tablets, handheld gaming devices, smart phones, and even

large, high-quality screens in home theaters for enthusiasts aiming to capture the traditional

theater experience but with added convenience and comfort. Additionally, consumers can access

an impressive array of films from network and cable television, packaged media such as DVDs

and Blu-Rays, video-on-demand services, and websites. As Yves Caillaud, Senior VP of Warner

Home Video and Digital Distribution and Chairman of the Digital Entertainment Group-Europe,

observed, “Consumers really are spoiled by choice” (DEGE, 2011). Jim Hedges, CFO of ABC,

observed “Historically, viewers consumed television on the big three networks when it was

programmed by a network executive . . . Today consumers are programming their own

‘networks’ by using the many options available to them” (Ulin, 2010).

This unprecedented abundance of viewing options has reshaped the economic structure of

the film industry as distributors attempt to maximize profits as newer exhibition methods

compete with as well as complement existing methods (Vogel, 2011). There have been more

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window shifts in the last 5 years than in the previous 25 years (Ulin, 2010). The challenge for

distributors is to combine new and old exhibition methods as they come into conflict, typically

done by slowing adoption of new methods as executives struggle to find a balance between the

conflicting methods that does not shrink the overall pie (Ulin, 2010). Typically, however,

sequencing will shift in favor of technologies that can realize the marginal revenue contribution

at the fastest rates (Vogel, 2011).

Unquestionably the largest change in recent years, and perhaps in the entire history of

intellectual property distribution, is the advent of digital distribution, allowing users to choose

from thousands of films, television shows, and other digital content and begin viewing

practically instantly (DEG, 2008b). One-third of homes in the United States stream videos

(Gruenwedel, 2012b) and Netflix alone accounts for an eye popping 32.7% of all domestic

internet traffic from 6 to 10 p.m. (Wasserman, 2011).

Digital has also encouraged distributors to adopt “second screen” strategies to provide

“customers with opportunities to enjoy their favorite content . . . between a wide range of

products than can share content, including televisions, tablets, smart phones, PCs and game

devices” (DEG, 2012a) as, according Thomas Gewecke, president of Warner Bros. Digital

Distribution, “consumers expect to have easy access to their content, whenever and wherever

they want” (Prange, 2012). Computers accounted for only 45% of Netflix traffic while gaming

consoles, set-top boxes, smart TVs, and mobile devices continue to grow in popularity

(Wasserman, 2011). Additionally, research shows most people under 30 already utilize their

computers and mobile devices as primary sources of consuming content (Ulin, 2010) while a

separate study found that over 25% of video watching occurs away from the TV (Gruenwedel,

2012b).

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To this end, five of the six major studios (excluding Disney) plus mini-major Lionsgate

support the digital UltraViolet format, which allows a single household to create an account for

six family members to access their films and TV shows, and later music, books, and other digital

content, from retailers, cablers, and streaming services on up to 12 registered devices covering

most of the hardware on the market (“Hollywood studios announce support for UltraViolet

format”, 2011). Three streams are possible at a single time and content can be downloaded and

transferred onto physical media, like recordable DVDs, SD cards, and flash memory drives

(Graset, 2011). In an effort to balance old exhibition methods against the new without eroding

the overall total, UltraViolet-enabled Blu-Ray discs have been introduced as distributors clearly

try to maintain value in packaged media (Adams and Cryan, 2012).

When windows do overlap, the competition between exhibition methods and the drive to

sustain consumer interest in a particular film has lead to a wide variety of developments designed

to enhance consumer experience as a method to differentiate between overlapping windows.

Perhaps the first of these to be widely used has been the special features included in DVDs.

Additional and alternate scenes, extended, uncut, or unrated versions, audio commentaries,

behind the scenes vignettes, outtakes, gag reels, crew and cast interviews, and more have all

become standard fare, and all are possibilities that were not available or practical in the theatrical

release or in preceding home entertainment formats. When the DVD format was launched in

1997, the format’s superior sound and visual quality were considered its selling point over VHS,

but after a short time special features were being hailed by an impressive chorus of home

entertainment industry experts (Arnold, 2000). Buena Vista [now Walt Disney Studios Home

Entertainment] President Bob Chapek stated the DVD format “affords us [the opportunity] to

make it an all-new entertainment experience . . . beyond watching the movie.” “DVD allows you

30


to reinvent the product” echoed Mike Dunn, Executive VP of Fox Home Entertainment.

Consideration for the DVD special features is even worked into the production of the film

itself (Arnold, 2000). “Now, there is great cooperation between the video and theatrical

production departments in getting materials really early,” said Marshall Forster, Senior Sales VP

for Columbia TriStar Home Video.

And the additional effort put into special features has paid off. Artisan Sales and

Marketing President Jeff Fink noted a “significant upside in sales compared to what we would

have done if the product had been brought out on VHS only,” while Craig Kornblau, President of

Universal Studios Home Video, asserted special features are “an absolute requirement to do big

numbers on DVD.” By all accounts, special features were successfully utilized as a method to

compliment revenues from theatrical exhibitions.

Interestingly, special features also serve as an excellent example to highlight the opposite

side of film distribution competition as well. By 2010, when distributors felt rentals were

carving too much out of DVD and Blu-Ray sales, special features were being removed from

rented media and consumers who went to view the special features were met with a message

stating “This disc is intended for rental purposes and only includes the feature film. Own it on

Blu-ray or DVD to view these bonus features and complete your movie watching experience”

(“Studios Crippling Netflix Rental Discs”, 2010). This example also illustrates the power of

distributors to favor one exhibition method over another in an effort to maximize their overall

profit, even if at the expense of a specific exhibitor’s profit.

As a final note, pragmatic financial concerns often find their way into distribution

sequencing and window decisions, such as when different divisions within the same distribution

company compete or when quarterly and annual performance reports are due (Ulin, 2010). One

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example is Paramount’s decision to delay the release of Shutter Island to February 2010 instead

of releasing in late 2009 (Waxman, 2011). Since studios book the cost of a film in the year of

release, a late December release where the full brunt of the cost is accounted for with little

opportunity available to realize any revenue can wreak havoc from a bookkeeping perspective

(Waxman, 2011).

Piracy

Although a thorough discussion is well outside the scope of this study, piracy can be seen

a separate window of release (Eliashberg, Elberse, and Leenders, 2006), the essence of which is

earlier or at least simultaneous access and lower prices (Ulin, 2010). While the greatest

successes of the internet are often tied to free and ubiquitous access to information (Ulin, 2010),

the ad hoc watch-for-free-everywhere-now structure of piracy undeniably threatens distributors

(Ulin, 2010).

The complete size of the problem is debatable. In an oft cited study by the MPAA,

Siwek estimates $20.5 billion are lost to the U.S. economy due to film piracy with an additional

$37.5 billion lost to music and software (MPAA, 2011a). However, as Raustiala and Sprigman

(2012) point out, not all downloads amount to lost revenue, especially in instances where the

pirated copy would not have been purchased anyway. Additionally, Sanchez (2012) widely

criticizes the methodology Siwek uses and references a study specifically performed by L.E.K.

Consulting for the MPAA which estimates losses from piracy at $6.1 billion, the majority of

which was copied DVDs with $2.3 billion attributed to the internet going as far back as 2005

(Ulin, 2010). However, in a comprehensive study of how piracy impacts are estimated, the U.S.

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Government Accountability Office determined that the economy wide impact of counterfeiting

and piracy on the film industry is unknown (United States Government Accountability Office,

2010).

However, although the exact extent of the problem is difficult to determine, nonetheless

the U.S. Government Accountability Office study concluded “piracy is a sizeable problem,

which affects consumer behavior and firms’ incentives to innovate.” Even absent fully reliable

statistics on illegal downloads versus legal purchases, most agree legal watching is simply a

fraction of overall internet viewing (Ulin, 2010). The Pirate Bay, only one of many such sites, is

the 76th most trafficked website in the world (MPAA, 2011b) and a 2011 study estimates an

amazing 23.8% of all non-pornographic internet traffic was related to copyright infringement

(Envisional, 2011).

Regardless of the exact size, however, the impact of piracy can be seen in the distribution

decisions surrounding sequencing and windows. Simultaneous global release is often used to

thwart unauthorized copying (Vogel, 2011) and online piracy is considered as the largest threat

to legitimate digital distribution (Cooper, 2012).

Customer as Ultimate Arbiter

Ultimately, however, the sequencing and windowing of exhibition methods is up to the

consumer, who will determine which exhibition methods survive and whether entertainment

revenues will expand or contract (Ulin, 2010). In discussing the balance between DVD sales and

online adoption, DreamWorks Animation CEO Katzenberg cautioned “We must not undercut

our bread and butter [the consumer] . . . The consumer decided when the VHS was obsolete . . .

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Not the hardware manufacturers, not retail, not us” (Ulin, 2010).

Key Markets

Domestic Theatrical Market

Initial performance of the domestic theatrical release overshadows and largely determines

success in all subsequent markets, both in terms of what the film can command from post

theatrical exhibitors (Vogel, 2011) and also due to the media attention surrounding theatrical

releases that drive awareness that can be amortized over the life of the film and can drive

consumption for months and even years (Ulin, 2010). As one industry insider described,

“Theatrical exhibition is the major factor in persuading the public what they want to see, even if

that public never sets foot in a motion picture theater. And how well and how long a picture

plays in theaters has everything to do with its value in other markets” (Daniels, Leedy, and Sills,

1988) due to a combination of advertising, media attention, and word-of-mouth (Eliashberg,

Elberse, and Leenders, 2006). In more muted language perhaps suitable for public filings,

DreamWorks Animation (2012b) recognizes that films that achieve success in the domestic

theatrical release tend to experience success in the home entertainment and international

theatrical markets, although still simultaneously cautioning investors that domestic theatrical

performance is not the only factor influencing a film’s success in subsequent markets. However,

it is typical that a film deemed a theatrical failure is a failure, but a film deemed a theatrical

success is a “cascade of success” (August, 2011).

Strangely, the domestic theatrical release has remained as relevant as ever, if not

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increasingly so. In other industries, traditional outlets are typically overtaken by newer channels

of distribution and the traditional outlet dwindles in importance and may even vanish entirely

(Ulin, 2010). In the film industry, however, the domestic theatrical release has become even

more important to the success of a film in later distribution channels (Ulin, 2010).

However, in spite of its importance, a theatrical release will seldom recoup the

investment in a film and can be properly seen as a loss leader that creates awareness of the film

for subsequent windows (Ulin, 2010). Approximately 80% of films do not recover even printing

and advertising costs during the domestic theatrical release (Friedman, 2004). Most distributors

are reconciled to lose money at this stage and are not necessarily deciding to pull the film off the

basis of continued theatrical revenue but rather on the opportunity costs of not showing other

films combined with continued marketing costs (Ulin, 2010).

As an example, in 2004 the six major studios combined for a $2.2 billion loss on $7.4

billion in domestic theatrical revenues, spending $1.30 in expenses for every dollar in revenue

(Epstein, 2005). However, considering the domestic theatrical release is but the first trigger

among release windows (Ulin, 2010) and domestic theatrical revenue is but simply the revenue

from domestic theatrical exhibitions (Ulin, 2010), the post theatrical market has become the

primary source of profit (Vogel, 2011). Again using 2004 as an example, DVDs brought a profit

of $13.95 billion from $20.9 billion in revenue and television realized a $15.9 billion profit from

$17.7 billion in revenue, for a total profit of $27.65 billion from the 59.5 billion in revenue

among the six major studios from domestic theatrical, DVD, and television markets combined

(Epstein, 2005).

As important as the domestic theatrical release is, the performance of a film is difficult to

predict because of each film’s uniqueness and the complex and dynamic environment it enters

35


into (Vogel, 2011). William Goldman, Oscar-winning screenwriter, famously described the

correlation between a developed idea and commercial success as “Nobody knows anything”

(Ulin, 2010). As such, a film’s initial value as part of the distributor’s portfolio is grounded in

subjectivity (Ulin, 2010).

However, certain external factors do tend to influence performance, such as ticket prices,

running times, season, weather, the number and quality of theaters, number of seats, and

competing releases (Vogel, 2011). The only overwhelming predictor of a film’s success is the

number of screens it plays on (Elberse and Eliashberg, 2003), placing distributors in a position to

court exhibitors for the valuable resource through the convincing use of marketing and well-

known movie stars and directors (Ulin, 2010).

Of the domestic theatrical release window, the opening weekend is largely the barometer

for judging a film’s success and the release is typically the most heavily marketed (Ulin, 2010).

Given the importance of a strong domestic theatrical performance, a successful opening weekend

can fuel downstream markets that generate revenues for years (Ulin, 2010).

In general, drop off from the opening weekend is approximately 50% and a film that

drops off significantly more than expected, such as 60% to 70%, may be perceived to have not

been well received and can be in trouble (Ulin, 2010). This opening weekend decay pattern

results in distributors crafting aggressive marketing campaigns for what is essentially is a film’s

one shot at a successful release (Vogel, 2011). However, the bigger the opening week the

steeper the decay will likely be upfront (Ulin, 2010). Additionally, a more sophisticated decay

may be built utilizing other factors such as holiday weekends, but nonetheless week to week

performance is still measured as the deviation from the expected decay (Ulin, 2010).

Unfortunately for an underperforming film, screens will be allocated to other films,

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making a second weekend rebound a rarity (Ulin, 2010). Compounding the issue is that after

tens of millions have been spent to convey a specific marketing message to audiences, it is

virtually impossible to recover after a weak opening, both because of the compromised message

and because the distributor will mostly likely prefer to spend valuable marketing money on films

still considered viable (Friedman, 2004).

Compiling information from The Numbers, of the 137 films initially released on or after

January 1, 1995 that grossed over $200 million domestically in adjusted dollars, $9.9 billion of

the $39.8 billion grossed in total came on opening weekends, or 24.9% of a film’s total domestic

revenue. Family films showed virtually the same pattern, grossing $2.8 billion out of $11.7

billion on opening weekends, or 24.2%. However, this trend appears to be creeping upward, as

even large films are tending to have only one or two weeks of strong theatrical performance as

opposed to more evenly distributed performance over longer weeks as was previously

experienced (Vogel, 2011). Of the 27 films initially released in 2009 to 2011 that grossed over

$200 million domestically adjusted dollars, $2.3 billion of $8.0 billion (28.2%) in total domestic

revenue was realized on opening weekend. Of the 7 films that met this criterion in 2011, $676

million out of $1,869 million came on opening weekend, or 36.2%.

As a result, selecting release dates for films has become critical, partially because of the

film’s opening weekend revenue and also because financial agreements with theaters give the

distributors a greater percentage of the revenue during the first weeks of release (“Trying to

enhance new films’ prospects”, 1991). Barry Reardon, President of Distribution at Warner

Brothers, cautions “If you don’t pick the right release date, you can destroy a movie” (“Trying to

enhance new films’ prospects”, 1991). DreamWorks Animation (2012b) considers the

scheduling of optimal release dates as critical to success.

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There are a number of outside factors than can impact a film’s release date, which can

either be programmed in advance, such as the Olympics or national elections, or news events,

such as wars or natural disasters (Ulin, 2010). Additionally, these outside factors offer additional

competition for precious media space as well, making it more difficult and expensive to market a

film that consumers have an increased chance of opting out of anyway (Ulin, 2010).

Distributors can also improve a film’s chances by selecting a release date during a peak

weekend or peak season. Using data from 1969 to 1984, Murphy (1984) identified eight peak

weekends for domestic theater attendance: President’s Day, Easter, Memorial Day,

Independence Day, Midsummer, Labor Day, Thanksgiving, and Christmas/New Years and Einav

(2007) found essentially the same results using data from 1985 to 1999. Memorial Day,

Independence Day, Thanksgiving, and Christmas weekends have been identified as “prime real

estate” (Ulin, 2010) with the summer being the peak season, where from 1983 to 1992 between

35% and 41% of the entire year’s revenue occurred during the summer months, averaging 37.8%

(Vogel, 2011). This concept is generally extended into the international market, although the

peak dates can vary from country to country due to different holidays, school schedules, and

other competing activities (Vogel, 2011).

However, peak weekends are no secret to distributors and now a film with two or three

relatively clear weeks is rare (Ulin, 2010). Competition from within the film industry originates

from three sources: 1) competition from films being release from the same distributor, 2)

competition from films targeting the same demographic or in the same genre, and 3) generic

competition from other films being released (Ulin, 2010). As a result, distributors are

continuously evaluating competitor films that open immediately before, during, and immediately

after a release (Ulin, 2010). DreamWorks Animation (2012b) pays particular attention to

38


expected release dates of other films produced by other animation studios, although attention is

paid to expected release dates of live-action and other “event” films vying for the same broad

audience appeal. In part cooperative and part competitive behavior, studios claim release dates

early to ward off potential competitors by commonly mapping out peak weekends years in

advance (Ulin, 2010). For example, the date for Harry Potter and the Sorcerer’s Stone was

advertised three years in advance (Fellman, 2004). Distributors face an interesting struggle

between attempting to capture as much revenue as possible during peak release periods while

simultaneously avoiding competition for audiences (Krider and Weinberg, 1998). In the midst of

multiple event films during the summer of 1995, film executives explained the unexpectedly

overall weak domestic theatrical performance as the failure to properly de-conflict popular films,

as “too many expensive movies stacked too close together at the beginning of the season . . .

[resulted in] one big movie [being] ‘cannibalized’ by the next one” (“For movies, it’s the dog

days, 1995).

At least one interesting example of competition for release dates involved DreamWorks

Animation and Pixar. In 1994, Pixar’s Creative Chief John Lassiter pitched the idea for an ant-

themed film to Disney executives, which at the time included Jeffrey Katzenberg (Fleeman,

1998). Katzenberg left Disney soon after and co-founded DreamWorks SKG with director

Steven Spielberg and record executive David Geffen (DreamWorks SKG Studios, n.d.) and,

coincidentally or not, almost immediately began work on another ant-themed film appropriately

labeled Antz (Burrows, 1998a). When Pixar’s A Bug’s Life was scheduled to open on November

25, 1998, directly opposite of DreamWork’s Animation traditionally animated Prince of Egypt,

Katzenberg reportedly offered to cancel the development of Antz if Pixar would agree to move

the release date of A Bug’s Life. When Steve Jobs, then-CEO of Pixar, declined (Burrows,

39


1998b), Katzenberg instead ordered the expedited production of Antz, moving its release date

from March 1999 to October 2, 1998, eight weeks ahead of Pixar’s A Bug’s Life, arguably with

the intent to uncut Pixar’s theatrical release (Hill, 2001). This set off a small series of opening

date shifts as DreamWorks Animation moved The Prince of Egypt back to December 18th,

prompting Disney to bump the release of Mighty Joe Young to December 25th (Fleeman, 1998).

Similarly, another conflict involving DreamWorks Animation erupted in 2009, when,

following the success of the 3-D release of Avatar, Warner Bros. made the last minute decision

to convert Clash of the Titans to 3-D, bringing it into competition with DreamWorks

Animation’s How to Train Your Dragon for the 3,500 domestic 3-D screens (Verrier and Fritz,

2010). The crunch was made worse when considering both films were following the immensely

popular Alice in Wonderland, which had unexpected staying power (Verrier and Fritz, 2010).

Other factors influencing the release date might include a director’s or producer’s

preference for a specific date or the tendency to release sequels on the anniversary weekend of

the original (Ulin, 2010). For example, Dr. Seuss’ The Lorax was released on March 2, 2012, on

the 108th birthday of Dr. Seuss (Corliss, 2012). Additionally, films with themes tied to

particular seasons or periods of the year, such as a film about Christmas or about baseball, will

drive a release during that relevant period (Ulin, 2011).

Aside from theatrical competition, films face competition from a number of substitute

products, not the least of which is the post theatrical market. With high definition television

(HDTV) launched in 1998 (DEG, 2006) and Blu-ray in 2006 (DEG, 2007), HDTV has become

“no longer a luxury option. It’s standard” (Taub, 2008). By 2011, with 70% penetration in the

domestic market (Chacksfield, 2012), 74.5 million households had HDTV and 40 million

households were Blu-ray capable (DEG, 2012b). The average HDTV purchased in 2011 was

40


44” (Gruenwedel, 2012a) and with televisions possessing “greater resolution, higher contrast,

wider color gamut, and lower power consumption”, some even capable of enhanced user

interfaces such as voice, facial, and gesture control (DEG, 2012a), a film rental for

approximately $5 can be an attractive alternative for a family of four who could easily spend

$100 on a night out that centers on going to the theater (Ulin, 2010). Given the ability to enjoy

multiple viewings and to have multiple viewers of the same film for the same price, Table 4

shows the average cost of film viewing to be much cheaper at home.

Table 4
Approximate cost of film viewing per person-hour, 2010
Source Cost
Theater 6.00
Pay cable channel 0.50
Home video 0.60
Commercial television 0.06
Source: Vogel (2011)

Still, it is important to note no matter how low the price at home, theater admissions

demonstrate people nonetheless enjoy “going out to the movies” (Vogel, 2011), with 63% of

consumers describing the theater as the “ultimate movie-watching experience” (MPAA, 2007).

Consistently since the 1960s, approximately 8% to 10% of the domestic population buys

admission to a theatrical exhibition in a typical week (Vogel, 2011) and 80% of consumers

believe their experience was time and money well spent (MPAA, 2007). In a resounding victory

for Hollywood, even piracy cannot replace the theatrical experience (Cooper, 2012).

Although it is doubtful it factors into consumer decisions, packed theaters favor the

distributors when considering profit per viewing as well. A single viewing in a theater can net a

distributor between $3.00 and $5.50 whereas in the post theatrical market it might typically be as

41


low as $0.20 per viewing where several people can watch a single viewing or one person can

enjoy multiple viewings without incurring additional charges (Vogel, 2011).

Competition also comes for a variety of other large entertainment events as shown in

Table 5. However, for the same family of four, tickets for major professional sporting events

and theme park admission can run from around $80 to over $300 before even considering food,

parking, babysitting, and other ancillary expenses. Additionally, major professional sporting

events are limited in number during the year, typically limited to areas with large populations,

and tied to specific times and specific seasons of the year, whereas theaters are conveniently

ubiquitous and offer staggered schedules for a wide variety of films.

Table 5
Comparison of Substitute Products, 1995-2011
Domestic Theaters Major Professional Sporting Events Theme Parks
Average Price
Avg Adjusted Avg
Year Price Price Attendance NFL NBA NHL MLB Attendance Price Attendance
1995 4.35 6.22
1996 4.42 6.14
1997 4.59 6.24
1998 4.69 6.27
1999 5.08 6.65
2000 5.39 6.83
2001 5.66 6.97
2002 5.81 7.04
2003 6.03 7.15
2004 6.21 7.17 54.75 46.00 45.00 19.82 32.85
2005 6.41 7.16 58.95 45.28 44.55 21.17 33.57
2006 6.55 7.08 1,449 62.00 45.92 42.13 22.30 137 34.46 341
2007 6.88 7.24 1,400 67.11 48.33 45.25 22.77 137 35.16 341
2008 7.18 7.27 1,364 71.00 50.00 48.72 23.50 141 35.95 347
2009 7.50 7.62 1,415 133 342
2010 7.89 7.89 1,341 76.47 47.66 54.25 26.74 132 339
2011 7.93 7.69 1,285 77.36 48.48 57.10 26.91 133 350
Note: All attendance figures in millions

Source: MPAA Theatrical Market Statistics, 2005-2011 and National Association of Theater Owners 2011 State of the Industry Report

42


Table 6 shows the actual and adjusted domestic theatrical gross from 1995 to 2011 along

with the international and worldwide actual and adjusted gross. In spite of economic turbulence,

adjusted domestic revenues show that domestic theatrical performance holds relatively steady

with a $9.8 billion average and a standard deviation of only $0.9 billion. When only considering

the past 10 years, these numbers are even more favorable, with a $10.4 billion average and a

standard deviation of $0.5 billion.

International Theatrical Market

No less than 60% of revenue has been generated in international markets since a

considerable spike in 2004 with approximately 65% of the total revenue from 2004 to 2011

being from the international market (MPAA, 2012). The top 100 films of any year have

consistently drawn half of their theatrical revenue from international markets (Vogel, 2011) and

often a major studio release can have more screens booked internationally than domestically

(Ulin, 2010). DreamWorks Animation (2012b) reports approximately 64% of theatrical

revenues comes from international markets.

Additionally, most predict continuous increases in the global theatrical revenue driven by

emerging markets in Asia-Pacific, Latin America, and Central and Eastern Europe countries

(Cooper, 2012). While piracy thrives in Russia and China, theatrical revenues grow even in

these notorious markets as they develop theatrical capability (Cooper, 2012). During 2011 in

China alone, an average of eight new theater screens were added each day (Cooper, 2012).

This strong performance in the international market has led distributors toward shorter

43

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