Future of Film III: The Crash of ‘Film as a Platform’
Studios have successfully transformed the theater from a profit center to a lucrative service platform - but the gold rush may crush industry returns. Here’s how it can be saved.
In Part I, I sought to dispel the belief that the Summer Blockbuster 2013 season was an unmitigated disaster. Instead, it was a not only a predictable outcome but also consistent with the strategy the Big Six studios have been pursuing for years. In Part II, I showed that this behavior was not only rational, but highly lucrative. The primary goal of the theatrical channel is not profit maximization – or even profit, per se – but the creation of comprehensive multimedia platforms.
We can see the implementation of this strategy clearly:
Over the past decade, the Big Six studios have been continually decreasing the number of films they make a year (remember, there’s about a two year lag due to production timelines) and despite this, they’ve managed to retain their share of the total English language box office. That being said, this share maintenance has come at great expense: in 2013, the majors released 32% fewer films than they did in 2003, but spent 75% more per film.
The majors have successfully transformed their products into truly mass audience ‘event films’. While these films typically do not deliver a positive return – and certainly not a sufficient IRR – they establish a platform through which entertainment becomes a recurring service. To that end, the journalistic focus on film ‘super-franchises’ largely misses the point.
Disney’s ”Marvel Cinematic Universe” is the best example:
While many of these product lines existed before the Marvel Cinematic Universe (MCU) took off, the films have undoubtedly catalyzed sales of franchise-related comic books and merchandise. What’s more, they’re enabling a series of new media products, including broadcast and cable television programming (with the latter generating 60% of Hollywood profits) and earned Marvel a spot alongside Mickey Mouse at Disneyland. Taken together, this set of discrete products establish an ecosystem whereby MCU offers fans not just the occasional film, but a continuous and increasingly integrated multimedia experience. While this does increase risk of an individual property or product ‘tainting’ Disney’s broader portfolio, it can also be self-propagating if done well. Furthermore, it helps Disney studios diversify its non-theatrical revenues away from the lucrative but in-decline home video (DVD) market.1 It’s worth mentioning, too, that Marvel spent nearly $1.5B to establish the MCU platform – and only three of its six ‘Phase 1′ films turned a theatrical profit. In fact, Marvel lost an average of $50M per film leading up to The Avengers.
Though MCU’s model is largely unmatched today, it is quickly becoming a standard. Star Wars has six films (a new trilogy and trio of spinoff films focusing on individual characters) and a TV series all on the way, and section of Disneyland green-lit for construction. Sony has jammed The Amazing Spider-Man 2 with a series of new villains and characters intended to become their own spinoff series that will culminate in an Avengers-style Sinister Six series. Not only is X-Men: Days of Future Past also abound with characters, it focuses on a time-travel plotline that will resuscitate several “dead” ones 21st Century Fox hopes to spin off. Fox has also hired Simon Kinberg (who wrote three of the past five X-Men films, is writing an upcoming Star Wars film and co-creating its spinoff TV series) to re-establish its Fantastic Four franchse and potentially weave it into X-Men. Warner Brothers, whose corporate parent owns DC Comics, is also ramping up its own version of Marvel-style series with the 2016 release of Batman vs. Superman (which includes Robin and Wonderwoman). It’s not just Sci-Fi films, either. Between 2006 and 2011, Cars was generating more than $2B a year in merchandise, driving Disney to green-light 2013′s Cars 2 and spin-off Planes and Planes: Fire & Rescue, due this year. Cars Land has since been added to select Disney theme parks and a Cars 3 is already in preproduction.
How this is going to change – and then imperil the film industry
The effects of this transformation and strategy will be both wide ranging and long felt – and not just by the Big Six or even movie theaters. First, non-platform films will continue to exist. Though they’ll be up against the marketing might of mega-franchises, reduced competition should enhance attendance per film, and therefore returns – especially if audiences begin to tire of mass-market tent-pole films.
Second, we’ll see the major studios investing heavily in the most underdeveloped ancillary medium: video games. Over the past decade, franchise platforms such as Harry Potter and Transformers continually dominated the box office, DVD sales and their original product categories (books and toys). However, only a handful of series have meaningfully penetrated the video games industry, which generates twice the revenue of motion pictures and holds immense storytelling potential. This failure appears to stem more from the sub-standard quality of movie-based video games, rather than consumer interest. This is likely tied to the fact that studios typically license rights to the highest-paying development house or contract out their production, rather than developing them internally. Going forward, I expect the major film studios will begin building out their video gaming and apps divisions and establish a more cross-medium, synchronized approach to storytelling.
More important, however, is the impending ‘Film as a Platform’ implosion. Looking at 2016′s dense release schedule, theatrical losses per blockbuster are likely to increase considerably. Not only will increased competition drive down average attendance, it could push studios to invest even more into their film properties in the hopes of standing out. This itself isn’t a fatal exposure – studios will simply need to rely more heavily on ancillary revenues. However, the real issue is that further audience fragmentation will make it even harder to achieve the critical mass audience needed to support ancillary revenue streams. Worse still, the growing number of franchise films may end up flooding ancillary channels.
Ancillary markets such as home video, merchandising and children’s television can only absorb so much content. A child, after all, will not want a Christmas comprised of various X-Men, Star Wars and Avatar paraphernalia and parents are unlikely to purchase multiple bedroom sets. Television audiences, can support only so many series in a given genre (the Marvel Cinematic Universe will have 7 in 2015 alone). Though themed sets have been a strong sales driver for the Lego Group, optimizing marketing and inventory investments will limit the number of franchises they will support – especially in the holiday season. As a result, the deluge of ‘platform films’ is likely to significantly reduce the ancillary revenues studios rely on for film profitability. To make matters worse, it would take at least two years for studios to emerge from this crunch due to the fact films are released 1-2 years after investment/production decisions are made.
Saving The Bix Six
To manage their risk profiles, studios have a few options
1. Revise their Investment Strategy: The most obvious answer is for studios to reduce per-film spending and focus only on the most promising assets. Sony, in part due to the relentless attacks of Dan Loeb’s Triple Point Management, has announced that it will be cutting its 2014 summer slate from nine to four films and its annual releases to 18, compared to historical 20-25 pictures. Amy Pascal, Co-Chairman of Sony Pictures Entertainment, has also declared they won’t “work with directors who go over budget” and that those who do will “face real financial penalties”. Nevertheless, this will not address channel flooding nor the fact that the traditional major studio film budget rarely delivers a theatrical profit. For that to change, we would need to see industry-wide scaling back. Unfortunately, the Tragedy of the Commons suggests this is unlikely as long as there’s money left on the table. Still, studios would do well to increase their focus on original productions that cater to individual customer segments. Though this will reduce the potential upside, it will also limit downside risk and diversify studio portfolios away from the increasingly competitive tent-pole market. Between the reduction in films produced by the Big Six and their increased focus on ‘Entertainment as a Service’, non-franchise filmmaking may even offer studios greater average returns than ever.
2. Introduce Tiered or Variable Pricing: Another option is for Hollywood’s longstanding singular pricing model to evolve into one where films are priced based on their production cost, target customers or demand. Before 2013’s disastrous summer kicked off, Steven Spielberg forecasted that there would be “an implosion where three or four or maybe even a half-dozen mega-budget movies are going to go crashing into the ground, and that’s going to change the paradigm”, adding that viewers would “have to pay $25 for the next Iron Man” but only “$7 to see Lincoln.” Variable pricing is long overdue, but faces a significant hurdle: theatre operators. Theatres typically retain 45% of ticket sales and therefore have little incentive to support films that offer sub-standard returns per seat. Conversely, studios will be reluctant to offer operators $11 per viewer for providing the same service they provide for $4.
3. Offer Bundled Experiences: Rather than offer tiered/variable ticket pricing, studios are more likely to embrace selling different “experiences” to different customers. In June, Paramount sold a $50 ‘superticket’ to World War Z that allowed purchasers to attend a screening of the film before its public release and included a digital copy of the film after its release on video. A few months later, Paramount tweaked this offer for Anchorman 2. For $33, fans would see an advance screening of the film, receive an alternate version of the original Anchorman, a pre-ordered digital copy of Anchorman 2 and a $5 confectionary voucher. Not only did this enable Paramount to monetize a costless asset (digital film rights), it began normalizing the idea of window-based pricing among the most obsessive of film goers. Though the promise of supertickets might seem empty to some, it’s no different than the book industry’s use of hardcover, softcover and trade paperback books. With marquee films selling out up to six months in advance in some markets, some may purchase the tickets purely to avoid missing out. Studios could also extend this concept into different media, either bundling together multiple products (e.g. a film ticket, video game, 6 month comic subscription) or offering successive discounts to keep the consumer engaged. In doing so, studios would be able to improve stickiness and revenue stability, while minimizing downside risk.
4. Revise their Product Placement Strategies: Finally, I expect we will see a substantial increase in product placement. While premium cable TV programming is paid for purely by end-consumers, the vast majority of TV content is not. What’s more, the average television viewer could never afford to directly finance all of the content they watch. To fill this gap, the television industry relies extensively on advertising – why shouldn’t film? In many ways, a deeper move into embedded advertising makes sense: the motion pictures business has been more about selling other products, rather than theatrical entertainment for years now. Depending on the depth of the placement, this can also be quite lucrative for the studio. In 2012, Heineken paid MGM a reported $45 million for integration into Skyfall. In addition to receiving commercial and web games starring Daniel Craig as James Bond, the film also included a scene where 007 opts for neither a shaken nor stirred martini, but a Heineken beer. This also fits well with studio strategies of maximizing a threatical audience. As I explained in a previous piece, there may also be an interesting opportunity for films to enter select product partnerships based on “fit” and pay in part based on sales lift, rather than an outright fee. Regardless of whether the majors experience a downturn in ancillary revenues per film, they’re likely to look to advertisers to begin subsidizing their rising budgets.
The (Present) Future of Film
Journalists and analysts stressing about summer losses, swelling budgets and audience fatigue are missing the picture. The tent-pole film strategy has never been about theatrical returns, but generating lucrative ancillary revenue streams. In recent years, however, studios have looked to transform these streams into a multimedia sales platform by consolidating audiences and expanding the narrative canvas. Though this has the potential to generate immense returns for a studio’s parent company, this gold rush threatens to collapse industry returns by fragmenting audiences and flooding ancillary channels. Studios can mitigate some of this risk by pushing further into B2B revenue diversification and investigating new consumer models (e.g. experience bundles). However, as is increasingly the case on the silver screen, a series of brand-name players seem dead set on a spectacular showdown. Audiences should be thrilled.
Key Notes and Assumptions
 It’s also important to note that the majority of these revenues and profits exist outside the IRR’s quantified in Part II. While Marvel Studios would receive royalties for film-related tie-ins, the remaining proceeds are retained by the individual subsidaries before being tallied up by The Walt Disney Company. The same is true for products whose sales are catalyzed but not directly affiliates .