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Future of Film II: Box Office Losses as the Price of Admission

In attacking Sony, Dan Loeb misses the fact the film industry is not about theatrical performance, but B2B sales enablement. Box office losses are just the price of admission.

As the film industry battled record breaking losses during the summer of 2013, one of the world’s largest film studios faced a particularly pernicious challenge: shareholder activism. During the first half of the year, Daniel Loeb’s Third Point Management had bought nearly 7% of Sony Corporation and begun to publicly demand change in the company’s entertainment division. The business unit, which generated roughly 10% of consolidated revenues and 20% of operating income in FY 2013, had certainly seen better days. Though it took home an industry-leading 17% of the English-language box office in 2012, it was tracking for 5th place among the six “majors” and coming off box office bombs White House Down and After Earth. The two films had cost more than $450M to produce and market, but returned less than half that sum after theatre fees. This failure prompted a scathing response from Loeb in Third Point’s Q2 Investor letter: “We find it perplexing that [Sony CEO] Mr. Hirai does not worry about [the entertainment division]… instead giving free passes to Sony Pictures Entertainment[‘s] Co-CEO… Under Mr. Lynton and Ms. Pascal’s leadership, Entertainment’s culture is characterized by a complete lack of accountability and poor financial controls. To us, these latest blunders are prima facie evidence of our thesis…” In addition, Loeb characterized the studio’s upcoming slate as “bleak, despite overspending on numerous projects.”

These criticisms prompted a lengthy retort from Academy Award winner George Clooney, who told Deadline:

“(Loeb) knows nothing about our business, and he is looking to take scalps at Sony because two movies in a row underperformed? When does the clock stop and start for him at Sony? Why didn’t he include Skyfall, the 007 movie that grossed a billion dollars, or Zero Dark Thirty or Django Unchained? And what about the rest of a year that includes Elysium, Captain Phillips, American Hustle and The Monuments Men? You can’t cherry pick a small time period and point to two films that didn’t do great. It makes me crazy.”

Clooney’s points are sensible – and we also know that Summer Blockbusters are rarely theatrically profitable – but they also miss the purpose of Loeb’s remarks: he wants Sony to spin off its entertainment business. The desire to jettison an underperforming business unit of a diversified conglomerate is old hat for activists, but it’s here where Loeb makes a mistake. For all its glamour, theatrical entertainment is simply a rotten business to be in.

Though its products are not commodities, many of the industry’s competitive dynamics and characteristics suggest they could be:

  • Past success is not a predicator of future performance. Last year’s box office receipts do not influence current-year performance and year-to-year momentum translates into little beyond high spirits
  • Talent doesn’t ensure success. The most “valuable” stars, brand-name directors and veteran producers routinely produce box-office bombs
  • Hollywood brands are irrelevant. Aside from Pixar (whose brand is arguably in decline), consumers don’t pick films based on whether they were a Universal or Paramount production. Indeed, consumers rarely even know
  • All products are offered at the same market price. Regardless of the film’s production costs or target customers, end consumer pricing is largely identical

The effects of this are clear1:


Maintaining a leadership position – or even current market share – is extremely tough in the film industry. Each year, an average 4.5 of the six studios change ranking and by an average of two positions. Though sales leadership is most likely to generate hype for a studio, it ignores the question of profitability and whether executives are investing their money wisely.


The chart above (which you can think of as a studio’s gross profit margin) drills home how miserable the theatrical film market really is. Even the world’s largest, most well-funded and powerful studios struggle to maintain positive returns, with the ten year industry average at -15%. Collectively, the studios have lost $17B on $110B in marketing and production spend. The best performing studio, Fox, was down over $900M on $16.5B – largely due to 2009’s Avatar, which grossed a record breaking $2.8B globally. Note, too, that despite leading the box office in 2012, Sony was still stuck at a sub-zero return, suggesting the studio might have simply “spent” its way to the crown.


While this third chart is essentially a recut of the second, it answers a more intuitive question: how much did a studio spend to generate $1 in box office revenue. With approximately 53% of proceeds (60% globally, 45% in North America) retained by movie theaters, a studio needs to spend less than 47¢ for every $1 in revenue (on average), to generate a positive theatrical return. Over the past decade, the Big Six studios have achieved this individually only 10% of the time and not a single year has been cumulatively profitable.

Why then, do executives continue making films? They have few (if any) levers they can reliably play with, the success of individual films causes massive disruptions in annual performance and in the long run, performance is unlikely to break-even, let alone outpace market returns.

The answer: ancillary revenue. In 2012, box office receipts represented only 52% of revenue for the average film, with the remainder comprised of home video sales, pay-per-view and TV/OTT licensing, syndication fees and merchandising. After appropriating for related costs, as well as backend participation (Robert Downey Jr. took a reported $50M from Avengers) and corporate overhead, the average Internal Rate of Returns (IRR) for the majors jumps to roughly 80%1.


When compared, the point is clear: the motion pictures business is no longer about theatrical performance. Success at the box office performance, of course, still matters – and will be strongly correlated to licensing and merchandising value – but the goal is largely to recoup costs, not reap profit. Individual films, too, matter less than ever. In December 2012, Netflix purchased exclusive streaming rights to Disney’s entire catalogue starting in 2016. A few weeks later, HBO bought exclusive rights to Universal’s film library through 2023. What’s more, the above IRR excludes the proceeds retained by the license holder and not paid to the studio as a royalty. However, they often share the same corporate parent. Disney’s Marvel Studios, for example, will receive royalties from film tie-ins released by Marvel Comics’ subsidiaries, but it will not recognize related profits or benefit from increased overall interest in Marvel products and characters.

Why this Matters

First, the adage that a film needs to gross twice its production budget to ‘break even’ is as outdated as it is inaccurate.  Not only can theatrical losses be part of a successful film strategy, it has actually become commonplace. In fact, Disney’s enviable Marvel franchise has had only 4 of its 8 films to date recoup their costs at the box office. Despite counting the 3rd (The Avengers) and 5th (Iron Man 3) highest grossing films in history, the franchise’s combined theatrical return is only 22.5%. White House Down and After Earth may appear to be “debacles” to activist investors, their final cost is likely negligible. While the tentpole film strategy may appear dangerous (if not outright negligent), it’s actually quite rational. John Carter, which was certainly an abject managerial failure, was not as outlandish an investment decision. Paul Dergarabedian, President of famously claimed that “John Carter’s bloated budget would have required it to generate worldwide tickets sales of more than $600 million to break even…a height reached by only 63 films in the history of moviemaking”. Yet, the film did not need to break even. In fact, average returns (-16%) would still have left Disney $65M out of pocket (versus $160M). John Carter simply needed to garner a critical mass of viewers upon which Disney could build a multiplatform media experience. Though the cost of failure was immense, so too was the potential upside.

Since silent films first appeared on the silver screen, motion pictures has been primarily a B2C business, with film studios sharing revenue with theater operators. But over the past decade, the majors have transformed into an increasingly diversified B2B partner. Their job is not to bring eyes to their theatrical products, but to enable NBC to drive Sunday advertising revenue, ABC Studios to create a high-margin television series, HBO to collect monthly subscriber fees or Mattel to sell Cars toys. Entertainment, in short, has become both a platform and a service. While this strategy may seem to insulate the majors from all but the most superlative box office bombs, it has also put them on course for an inevitable crash. To find out more, read the final part of the Future of Film series here.

Key Notes & Assumptions

[1] Hollywood Accounting is infamous for its alleged exaggerations and inaccuracies. In assembling this piece, I’ve made a few key simplifications, such as allocating 100% of a film’s revenue and production & marketing costs to the ‘lead’ studio publishing the film. In reality, the studios often co-produce major films. 21st Century Fox, for example, greenlit Avatar only after another studio (not one of the big six) agreed to finance more than half of the film’s $237M production budget. For the major studios, I have also collapsed the roles of production and distribution, though they may only do one of the two functions for an individual film. Due to the opacity and non-disclosure of many of these agreements, this analysis would have been impossible without these assumptions. As the purpose of this series is not to analyze the performance of any one studio or year, but the average return from a film produced by the “Big Six”, I believe that these assumptions do not interfere with my conclusions.

  • Charlie

    To understand the mind-bending techniques of the old Madison Avenue set, see “Mad Men’s Guide to Persuasion” (