Tinseltown loses its magic

It looked like a surefire hit. The producers of Used Guys signed up Jim Carrey and Ben Stiller, as well as Jay Roach, the director of Austin Powers and Meet the Parents.

The film was a futuristic comedy, set in a time when women take control and cloned men are bought and sold like secondhand cars; apparently it was to have taken a wry look at contemporary gender issues. Millions of dollars were spent and sets constructed in Santa Fe, New Mexico.

Then, last summer, 20th Century Fox abruptly pulled the plug on the project, leaving the writers and stars in shock. The budget crept up to $112-million and the stars, as with most Hollywood projects, cut lucrative deals for a share of the future revenues. An unnamed Fox executive told The New York Times that the economics simply made ‘no sense”.

It’s a telling story about the state of Hollywood. On the face of it the film industry appeared to have a reasonably good year in 2006.

The six major studios — Disney, Fox, Paramount, Sony, Universal and Warner — together reported about $36-billion in revenue, roughly one-third of which came from their library of films. Cinema attendance was up after a poor 2005, even if there was some grumbling in the aisles about the number of sequels and remakes.

But the film industry is not a normal business. According to a recent report that is causing some uncomfortable shuffling in Hollywood, the combined release slate from the major studios last year (132 movies) is expected to lose $1,9-billion by the time it has run through the five-year cycle of theatrical release, DVD, pay and free-to-air television and every other source of income (a film’s ‘ultimates”, in movie industry jargon). The Fox decision to pull the plug on Used Guys now looks like a rare outbreak of good husbandry.

The report, Do Movies Make Money?, was put together by Hollywood insider Roger Smith for Global Media Intelligence, part of the Screen Digest research firm, and is being hawked to American investors by the Wall Street bank Merrill Lynch. It will make difficult reading for the bosses of the big corporations that own the film studios.

The report suggests that a combination of spiralling costs (driven in part by the demands of star actors and directors), a sudden slide in DVD sales and dipping or flattening revenues from television and the box office has left the studios dangerously exposed.

The problem was exacerbated by an influx of cash from outside investors, such as hedge funds, which left the business awash with money over which less control was exercised. The result is a business model that appears to be broken. ‘The bottom line is that costs have risen in nearly every facet of the business, while revenues are flat or even down in every sector,” Smith said. ‘Making movies has gone from a modestly profitable activity to one that now generates substantial losses.”

The report suggests the release slate for 2006 will earn $23,7-billion, down about 4,6% on 2004’s releases, while costs rose to $25,6-billion, up 13,2% on 2004.

The problem, said Smith, is that Hollywood got used to rising revenues and became increasingly profligate. He suggests the years between 1999 and 2004 might turn out to be a golden age. During that time DVD sales exploded, audiences flocked back to the cinema and new pay-television channels appeared in markets around the world. Movies greenlighted during those years were based on assumptions that the upwards trend would continue.

The studios, perhaps not surprisingly, are unwilling to get drawn into public discussions about potential future losses, although some dismissed Smith’s calculations anony-mously through the trade press. But even if his sums are not spot on, the trends that Smith highlights are undeniable. ‘It makes complete sense,” said Terry Ilott, director of the Film Business Academy at the Cass Business School in London. ‘It confirms what quite a few people have thought for a couple of years. Everyone suspected that margins must be under pressure and that profitability must be an issue.”

So where is the money going? Arguably the fastest-growing costs were participation and residual deals struck by talent and guilds, which give them a percentage of revenues on top of an upfront fee and can earn top stars $70-million to $100-million even when a film fails to make any profit.

Many in Tinseltown believe such a deal was behind the very public bust-up between Paramount’s parent company, Viacom, and Tom Cruise last year. Cruise was reported to take 20% of the revenue from films he starred in. Participation deals are generally kept secret, but one studio, Disney, helpfully divulges how much it spends on the deals in its financial reports. In 2002 it paid $154-million; that rose to $554-million in 2006. A back-of-the-envelope calculation suggests to Smith that Hollywood paid out $3-billion to its star names last year.

If the movies are not necessarily making money for the studios, they are making a lot of money for a few individuals. Analysts compare the amount of money paid to film stars during the boom years to the sudden influx of TV money that inflated footballers’ wages.

Dade Hayes of the trade bible, Variety, said participation deals were a concern at the studios. ‘The star cuts are gigantic. A lot of projects break down because things were going down a track that ended up being too expensive.”

In addition the studios are involved in an arms race in marketing costs.

The biggest marketing budget last year was $53,5-million for Cars, according to TNS Media Intelligence, followed by $45,5-million for Superman Returns. They also spend more on spectacular special effects. ‘Can there be any industry other than film that has used digital technology to increase costs?” Smith asked. ‘Special effects were costly and you used to have two, three or four minutes in a film. Now they have 40-50 minutes of special effects at $2-million a minute.”

He said movie executives allowed production budgets to soar, partly for fear of making a wrong decision. ‘The great fear is the Home Alone fear,” he said, referring to the film that made a child star of Macaulay Culkin.

‘The film was being developed at Warner Brothers on a promise that it would be made for $14-million. Well, the director came back and said the budget would be $17-million. Warner said no. So he called Fox and said, ‘Would you like the picture?’ and in 20 minutes they said yes. Well, Home Alone 1, 2 and 3 went on to make an $800-million profit contribution for Fox in the next 10 years.”

According to the report, almost all of the main revenue streams ground to a halt in the past two years. Box-office takes fell 8% since 2004 in the United States and 10% internationally. American films lose market share overseas (a record low of 55% in 2006). Revenues from TV also look a little wan. The growth in the number of dedicated subscription channels has slowed, while the free-to-air channels show fewer films in favour of their own programming.

But the biggest concern is DVD — the main engine of growth between 1999 and 2004. In the past two years DVD revenues dropped 11% to $11,1-billion.

‘It is undeniably true that DVD revenue, which was responsible for the big boom that happened in the past few years, plateaued and is now in decline,” said Michael Gubbins of Screen International magazine.

It is not immediately apparent where the revenue to replace slipping DVD sales will come from. It seems unlikely that consumers will pay the same amount for a download. Still, Gubbins thinks the financial state of play will lead the studios to push more quickly into new forms of media. ‘I think we will see an acceleration into things like video on demand and downloading your own content. They are small at the moment and they have been kept artificially small. No one will risk the existing revenues when they can’t yet be sure of new media. But I think there will be a lot more attention and a lot more of a push to accelerate this new world and to make it happen.”

In theory it should not be too difficult to rein spending back in. There are few fixed costs in film — ‘You get the same Tom Cruise for $25-million as you do for $5-million,” said Ilott. But the desire to do so must be there. ‘The studios look at gross, not profit. The kudos is taking $750-million or $1-billion at the box office. Nobody cares about making a profit for the parent company,” Ilott said. ‘Generating revenue is not difficult. You can have George Clooney and Brad Pitt and make Ocean’s 13, but that doesn’t mean you are going to make a profit.”

But even if Smith’s figures are correct, the studios are not about to go bust. Any losses will be cushioned by the profitable production and distribution of TV programming and the sale of DVDs from the film studios’ back catalogues. The studios are just single divisions of the likes of Time Warner, News Corporation and Viacom. The conglomerates bought into the idea that the film business is volatile, delivering huge profits one year and losses in another. The corporate board can be indulgent, said Smith, especially when the studio boss can introduce them to big-shot movie stars.

The only studios that win praise in the report for their more disciplined approach to costs are New Line (part of Time Warner) and Fox, the same studio that closed the shutters on Used Guys. ‘They made Fantastic Four for a mere $100-million, which might sound a lot, but you compare that with SpiderMan 3, which cost maybe $300-million,” Hayes said of Fox. ‘You do have to applaud their restraint.” —

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