Hollywood's Financial Collapse

Hollywood's finances are collapsing, along with other parts of "legacy media" including newspapers, magazines, television (particularly network television) in addition to the falling revenues at movie studios. Part of this financial collapse among all legacy media is the influence of the internet, offering alternatives from piracy to original content, part of it due to the recession with tapped consumers closing stressed wallets, but much of the collapse is due to legacy media's content being pretty miserable. Magazines are nothing but elitist propaganda with little to say to huge segments of the potential readership, newspapers have done their best to alienate their core readers (older White men), television long ago chased away males and older viewers, and movies consist of a few, highly profitable, but hugely expensive action-adventure tales, with myriad unprofitable "art" movies aimed at winning Academy Awards or hit-or-miss "chick flicks."

Hollywood for decades assumed the good times would roll, and the speed in which it is collapsing is catching everyone by surprise. None of their moves seem to indicate any indication of the central problem: their content is not very attractive beyond a thin elite, and the failure of the "Brandon Tartikoff Strategy" has not penetrated Hollywood's or legacy media's management. Leaving ample opportunities for new players outside Hollywood, Los Angeles, and New York, to create broadly appealing content for relatively few dollars and sell it at a profit. In the process, changing American culture the way deeply assimilated Jews who founded Hollywood did from Charlie Chaplin movies to Casablanca and It's a Wonderful Life.



As the Australian notes, Walt Disney and Universal changed studio heads, with Universal being shopped to Comcast by parent GE. The LA Times notes that DVD sales have collapsed as much as 25% for some studios.

For years, DVD sales, coupled with the growth in international markets, compensated for box office losers. On a typical movie, DVD revenue accounts for about half of a film's income, with the remainder split evenly between theatrical receipts, both domestic and international, and television, both pay and free channels.

But as the global economy tanked, so did DVD income. According to Digital Entertainment Group, DVD sales fell 9% in 2008 and were off 13.5% in the first half of 2009. The DVD ledgers are equally bleak overseas; owing to widespread piracy, some studios essentially have closed DVD operations in the once-profitable Spanish and South Korean territories.

Though new businesses such as digital downloads and video-on-demand are growing fast, they have come nowhere close to making up for the decline in disc sales. At the same time, foreign monopolies in paid television have driven down the formerly generous license fees paid to American studios for cable and satellite reruns, while increasingly popular local language productions (movies in Japanese made for Japan, in other words) have cut into the international box-office returns for U.S. productions.

Paramount Pictures, the only movie studio to report its finances separately, has seen its profits fall consistently. While revenue was growing until this year, Paramount's operating income has fallen like a boulder, down 22% in 2007 and 75% in 2008 until it swung to a loss of $148 million in the first half of 2009.

Without cash flows from DVD sales or foreign TV sales, Hollywood loses its main revenue model. Note how the influence of piracy killed Spanish language and South Korean DVD sales, in line with Eli Roth's observation that his movies were on sale in Mexico City for the equivalent of 25 cents. Hollywood for years simply assumed that DVD sales would continue, with at worst slower growth in revenue. Piracy, and simple disinterest in buying DVDs for such films as "Land of the Lost" or "Funny People" put that assumption to the test, where it failed.

Meanwhile, new capital has been almost unobtainable. Wall Street is not pouring billions into movies anymore, nor are the Germans (it was the closing of tax loopholes in Germany that helped kill "V.I.P." the syndicated Pamela Anderson television show) or Japanese. Hollywood had traditionally raised capital from outside sources, and now with rising production budgets faces severely reduced cash flows to finance their own continuing operations. Thus, built-in "sales hooks" of movies based on Baby Boomer to Generation X games and toys and comic books, from Viewmaster, Battleship, Monopoly, Transformers, to Spider-Man and Iron Man, with a smattering of tween girl and mother vampire movies and TV series (New Moon, Vampire Diaries), Harry Potter movies, and Da Vinci Code movies.

This comes as the Wall Street Journal reports that Wal Mart, the world's largest retailer, is scaling back DVD displays and inventory, in anticipation of a dismal Christmas retailing season. DVDs are not selling, according to Wal Mart execs (who have among the best inventory management software and reporting in the business) and are not driving traffic or sales. The article further states that:

As for DVDs, the Digital Entertainment Group estimates that overall U.S. retail sales fell 13.5% to $5.4 billion during the first half of 2009. At the same time, DVD rentals rose by 8.3% to $3.4 billion. Digital sales and rentals from services like Amazon.com Inc. and Apple Inc.'s iTunes rose 21% to $968 million.

Video on-demand revenue from pay-TV service providers, like Comcast Corp., is also rising. Comcast spokeswoman Jennifer Khoury says the company served 368 million total views on its VOD platform in July, up 11% from last year.

Meanwhile, studios have cut deals with services like Netflix Inc., the mail-order DVD rental service.

Meanwhile, Wal-Mart and other major retailers, along with several fast-food chains, have been adding low-cost DVD rental kiosks near store entrances provided by Redbox Automated Retail LLC, a division of Coinstar Inc.

Redbox's prominent placement and its overnight rental price of $1 are viewed by film studio chiefs as a threat to sales. Three major studios -- News Corp.'s 20th Century Fox, Time Warner Inc.'s Warner Brothers and General Electric Co.'s Universal Pictures -- are locked in a legal battle with the company and refuse to make their new titles available to Redbox until 28 days after their release. News Corp. owns The Wall Street Journal.

Starting with just 12 kiosks in 2004, Redbox is now expected to have 22,000 machines across the country by year-end.

This equates to a loss of $840 million of DVD sales for the first six months of 2009, as opposed to whatever fraction of revenues studios can obtain from DVD rental outfits. Business Week reports that studios receive around $16 for every DVD a retailer sells and only $12 for one Netflix buys, with 30-40% of each rental transaction (rental fees) from Netflix shared with certain studios, but only within the first six weeks of release. Older movies such as the Die Hard movies produce only the (lesser) DVD sale to Netflix. Redbox, offering DVD rentals for $1, is engaged in lawsuits with various studios over proposed terms, including blackouts and higher prices. Best Buy and Borders, decimated by DVD sales declines are clearing them off retail space.

At Borders Group, stores in the second quarter that had been open at least a year saw DVD sales plunge 48% compared with the same period in 2008, the company disclosed in an earnings call with analysts last month. Music CDs were also down dramatically, continuing a long trend, and Borders Chief Financial Officer Mark Bierley proudly told analysts last month that both categories will be a less important part of the company's business in the years ahead.

"The good news is that we've made the right strategic moves in this category...and multimedia now represents just 8% of our sales compared to 2002 when the category was at its peak of over 23% of sales," Bierley said during a conference call.

Owned by Coinstar Inc. (CSTR), Redbox kiosks charge $1 a day for movie rentals at supermarkets, drugstores and other retail outlets with significant foot traffic. The company has 15,000 of the kiosks in place and plans to have 20,000 in operation by the end of 2009.

According to Nathanson, Redbox presents "the most extreme risk" to the studio business model. Bernstein estimates that Redbox generates about 15 rental transactions, or turns per disk, compared with nine to 10 turns for Netflix and 6.5 turns for Blockbuster Inc (BBI).

"It is impossible to measure the potential loss of sell-through from each Redbox rental," he wrote. "But, by any simple math, Redbox is the worst cannibalization outcome of the three rental options given its higher turns per disc."

This has spurred the studios to go after Redbox. So far, Time Warner Inc.'s (TWX) Warner Bros., News Corp.'s (NWSA) Twentieth Century Fox and General Electric Co.'s (GE) NBC Universal have gone on record as demanding that Redbox wait about 30 days after a DVD is released to the public before offering it for rental. (News Corp. also owns Dow Jones, publisher of this newswire.)

While the Belmont Club at Pajamas Media has noted this financial collapse, and cited a PriceWaterhouseCoopers report on new media as evidence that the studios and legacy media face challenges primarily through the challenge of alternative content created and distributed cheaply through the internet, there is more than ample evidence to suggest an entirely different reason: value.

Or more specifically, loss of value to consumers by Hollywood and legacy media. Because consumers in hard times will not shell out $20 or more for "Land of the Lost" or "Funny People." They will rent the DVDs, for about $1, if it is convenient. Or buy pirated copies for about the same. None of this involves the internet, excepting the convenience of managing Netflix queues, or piracy, or video on demand, or downloads from Itunes or Amazon, or Hulu.com and its enormous library of old TV shows and movies. Hollywood's worst enemy is itself, and the mostly superior run of movies and television shows produced from say, 1939 through 1992 or so. Available cheaply, sometimes free, in a more convenient way than expensive purchases through retailers. People like to watch movies, together, on screens ranging from theaters to living room televisions. It took sustained, concerted effort by Hollywood to produce movies and television shows to wean people of this habit, but Hollywood's creative and executive ranks were fully equal to that task.

This is similar to the LA Times drop in circulation, from 1.1 million in 1989 to 739,000 in October 2008. As I noted in my post Failure of the Media Part Two: The Lingering Death of the LA Times this was due to the same factors that is hurting Hollywood now. Consumers were not willing to pay the price for a product they did not feel gave them value. The LAT changed from a middle of the road newspaper dedicated to serving its mostly White, Older, and Male readership to one dedicated to serving a thin veneer of wealthy, politically correct yuppies, the "Brandon Tartikoff strategy" that was also employed by NBC with the same trap. Which is the inability to create broadly appealing content to a mass audience.

Hollywood, newspapers, magazines, television, all fell into the same trap. Pursuing a highly educated, upscale demographic with lots of disposable income. Magazines such as Gourmet, Cookie, Modern Bride, and Elegant Bride are being closed by Conde Nast due to falling ad sales. The graphic below from the article shows the failure of targeting high income people when a recession hits.


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NBC has been unable to generate any audience for its shows, and is reduced to running low cost Jay Leno comedy-talk at the 10 pm hour. This is a problem shared, to varying degrees, by other networks.

What is clear is that the overall strategic advantages of legacy media, including Hollywood, has changed. Due to the recession and the difficulty of obtaining capital. Legacy media can no longer count on size being an advantage to raise capital from outside sources and "crush" through attrition various competitors. Low cost internet distribution and the personal computer revolution allowing content to be created cheaply means the legacy media, all of them, have huge cost structures that are disadvantages, while having cumbersome corporate and cultural layers that prevent agile and timely responses to economic and cultural conditions. Obama's approval ratings are at 50%, for example, meaning that there is little benefit from praising him as a living God, yet Magazines at the checkout counter and news channels and broadcasts (with the exception of ratings leader Fox News) present Obama as "bigger than Jesus." Complete with hagiographic coverage, and "debunking" of SNL skits that gingerly criticize the "savior." At least half their potential readership and audience does not approve of "the One" making this a dumb business move appropriate to a forced monopoly not a business scrapping for customers.

This sort of thing happens, not because the people in the legacy media, or Hollywood, are inherently bad, but because their system has rewarded orthodoxy and not had any immediate connection or feedback mechanisms for audience/readership responses. Newspaper and magazine writers and reporters don't get paid extra if their articles generate more reader responses, purchases of the newspaper or magazine on the newstand, and the like. Chris Matthews of "Hardball" does not get less money when his ratings go down and more money when they go up, from week to week. Instead, in a nepotistic, and often rife with casting couches, such as David Letterman's, getting ahead meant not performance related to the bottom line but adherence to group PC orthodoxy of the often inbred, second or third generation elites who comprised management of the legacy media. From the Harvard Mafia in the Simpsons and Conan O'Brien writing staff to the preponderance of the Ivy Leagues and second/third generation Hollywood among writer/producers, relationships not production has dominated legacy media, and left the media unable to adapt to the recession and permanent lower prices consumers will pay for information and entertainment.

With these permanent lower prices, be it Redbox rentals for $1 at convenient supermarkets, or piracy on the internet or street corners, or ad supported free Hulu.com views of say, "LA Dragnet" or "Married With Children" the ability to wring billions out of consumers wallets for specialized content is over. High prices for content means specialization, the upscale market pioneered by Brandon Tartikoff and spread throughout the media world, including magazines, newspapers, and Hollywood. The ability to supplement theatrical revenue for movies with foreign TV sales, DVD sales, and so on is simply gone. As is other people's money from Wall Street or foreign tax shelters.

Instead, new content creators, based outside of Hollywood, will have to create broadly appealing content because the amount of money they get from each sale or view will be small. The way to get rich in media is no longer being highly specialized, serving only segments of the market, like tween girls and moms, or upscale yuppies wanting an extra dose of PC from say, "Crash." It is by serving everyone, tween girls, their moms, young men, boys, adult men and women, married, single, divorced, middle aged or senior. Everyone. And in this case the future of media resembles the past: highly entrepreneurial men like Sam Goldwyn or Louis B. Mayer, who have a deep love for America and its people, and make entertainment aimed at getting the broadest possible audience. Since margins on each view or sale will be low. Probably, much of the content will be integrated, with content available on websites for free (ad supported) viewing, downloaded for free with embedded ads, downloaded for a modest cost with no ads but extras, and available for rent or purchase in DVD or Blu-Ray format for modest costs in mass retailers like supermarkets or online ala Amazon.

This is critical, because the sneering yuppie-ism, which at its worst contributes to an elitist, fractured culture that produces elitist, fractured politics, is no longer sustainable. The internet has accelerated this change, but fundamentally, the audience has simply concluded that paying $11 per ticket at the theater, or $22 for the DVD of "Land of the Lost" is simply not worth their money.