The Hollywood Economist: The Hidden Financial Reality Behind the Movies
By Edward Jay Epstein | Melville House | $29.95
OVER the past couple of years a perfect storm appeared to be threatening the hegemony of the major Hollywood studios over global screen entertainment: rising internet piracy, falling DVD sales, the declining value of deals with television networks around the world and an evolving global financial crisis that threatened to destroy the shadowy system of deals and investments that are Hollywood’s lifeblood.
Six months into the new decade, and on the surface at least, the outlook is much sunnier. James Cameron’s Avatar has reportedly earned almost US$2.75 billion at cinemas around the world; unadjusted for inflation, this makes it the most successful film in history. Avatar also kickstarted the resurrection of 3D, in the process eliminating audiences’ reluctance to pay a further premium for movie tickets. It was largely made in New Zealand, where a new suite of production incentives and subsidies has been introduced to try to maintain Hollywood-scale filmmaking. Within North America, states like Louisiana, Michigan and New Mexico are vigorously contesting the incentives game, competing with established locations in Canada, Australia and Europe, and other new players in Africa, Asia and South America, for the attention of Hollywood producers. In the process, some of the risks and costs of movie production are reduced, and the majors’ bottom line improves.
But, as so often in Hollywood, all is not quite as it seems. One of the oldest of the major studios, the eighty-six-year-old Metro-Goldwyn-Mayer, or MGM, is on the brink of bankruptcy. The collective voice of the studios, the Motion Picture Association of America, has found itself increasingly stretched, waging an unwinnable war against unauthorised filesharing and lobbying against plans for a new futures market trading in predicted movie box office returns (along the lines of the popular, and free, Hollywood Stock Exchange). And it remains to be seen whether 3D can turn around the gradual decline in cinema audience numbers, and none of the major players has worked out how best to make money from internet streaming and downloads. At least, not yet.
Screenwriter and author William Goldman once wrote that to understand the business of Hollywood, you need to realise that “nobody knows anything.” Journalist and author Edward Jay Epstein’s illuminating and instructive new book The Hollywood Economist finally puts the lie to Goldman’s much-repeated aphorism. Drawing on the extraordinary access he was granted to internal studio documents, to secret reports prepared by the Motion Picture Association for the major studios, and to distribution statements, budgets and contracts between the studios and stars like Tom Cruise and Arnold Schwarzenegger, and through his role as an expert witness in a lawsuit over the ill-fated film Sahara, Epstein is able to describe authoritatively the ingenious and ever-changing ways in which money is made and moved in Hollywood. While the ultimate financial performance of any given movie remains difficult to predict, Epstein shows that a large number of Hollywood players, and in particular the much-maligned studio executives who remain largely unknown beyond the pages of Variety or Hollywood Reporter, have always known an enormous amount about how to make money, despite the fact that the vast majority of their movies make a loss at the box office.
Much of what Epstein describes will not be new to anyone who has followed the business of Hollywood in recent years. Indeed, much of The Hollywood Economist won’t be new to anyone who has followed Epstein’s recent writings; many of the chapters are based on this prolific author’s articles in publications such as Slate.com, the Financial Times and the Wall Street Journal. This explains the book’s leaps across time, from the opening chapter, which draws on Epstein’s experience over a decade ago at ShoWest, the annual meeting in Las Vegas at which distributors and exhibitors plan campaigns for forthcoming films, to the closing chapters discussing the recent demise of Miramax and the prospect of the studios’ moving into online movie distribution.
Epstein offers a great deal of insightful commentary about matters like the techniques cinema owners use to encourage patrons to spend on the things that really make money – snacks and drinks (selling movie tickets at the candy bar rather than in a dedicated ticket box, putting extra salt on the popcorn to make people thirsty, and installing drinks holders in seats for mid-movie libation) – and his extraordinary insider access means that we hear about such strategies directly from the main protagonists, but throughout the book the commentary risks being overtaken by the speed with which things change in the movie business. The most significant recent development in cinema exhibition – the rise of 3D – doesn’t rate a mention, while in the few months since the final chapters were written, negotiations for the sale (and probable resurrection) of Miramax have proceeded apace. Meanwhile, a deal between DVD-by-mail and online streaming service Netflix and film producer Relativity Media threatens to explode the well-established system of release “windows” in which movies are progressively made available first in theatres, then on DVD, and then on pay and broadcast television. And perhaps the biggest unresolved story in Hollywood – the financial woes of MGM, nearly US$4 billion in debt and recently forced to kill its major cash cow by cancelling the forthcoming (and twenty-third) James Bond film – is nowhere to be seen.
Despite these absences, and despite the fact that much of the material in the book has been published before, The Hollywood Economist will be required reading for anyone with dreams of making it in Tinseltown, or indeed for anyone who wants to know how Hollywood really works. There are clear and instructive explanations of such key Hollywood terms as “fixed or guaranteed compensation” (up-front salary) and “contingent compensation” (profit participation, which for most people involved in making a film amounts to very little); “cash breakeven” (the arbitrary and uneven point at which contingent compensation becomes payable); “adjusted gross receipts” (the studio’s total revenues from a film, minus “off the top” expenses such as union dues and taxes); “gross/net points” (a proportion of the gross/net profits that forms part of contingent compensation – although well-honed creative accounting methods mean that, as David Mamet puts it, in Hollywood “there is no net”); and “official budget” and “cost budget” (how much a film supposedly costs to make, and the closely held actual cost of a film after subsidies, tax incentives, and product placement fees are accounted for).
Epstein also breaks down the returns to the studios from US and international box office, from DVD sales, and from output deals with television networks. In the process, he shows just how much weight the American discount chain Walmart carries in determining the content of films in production. Around 25 per cent of all DVDs sold in the United States, or around US$4 billion-worth in 2007, are sold by the corporation currently ranked number one on the Fortune 500. Walmart’s “decency policy” marginalises films containing scenes – principally graphic sex and nudity – deemed likely to offend the company’s major customers: American moms. As a result, sexual content in mainstream films, and new R-rated features, are becoming rarer and rarer. While Walmart’s policy principally affects the US market, it has flow-ons for the rest of the world because most films are first released in America, with their marketing campaigns and content shaped there.
The absence of suggestive nudity and sexual activity in many contemporary films is not only due to the market power of Walmart. It is one of the nine elements of what Epstein calls the “Midas Formula,” the recipe for Hollywood’s holy grail, the franchise, or “films with licensable properties that [can] generate profits in other media over long periods of time.” The nine elements are:
1. An adaptation of a “pre-sold” property, meaning a pre-existing, familiar, popular source such as a children’s story, a comic book, or a cartoon.
2. A child protagonist, in the first instalment of the franchise at least.
3. A fairytale plot involving the transformation of a weak protagonist into a hero with a mission.
4. The absence of nudity and sexual activity, which is critical to ensuring a PG-13 rating and which enables merchandising aimed at children and advertising in media aimed at children and teenagers.
5. Characters that can readily be licensed for toys and games.
6. Stylised, unrealistic and bloodless violence, again in order to ensure a PG-13 rating.
7. A happy ending that allows for future sequels.
8. Traditional or digital animation or enhancement of fantasy scenes.
9. A cast comprising non-A-list stars, in order to limit their capacity to negotiate contingent compensation deals that will reduce a studio’s returns.
As the Midas Formula demonstrates, Epstein is an insightful if not entirely original analyst of cinema; much of this is well known, but that does not detract from its utility for both (aspiring) practitioners and students of Hollywood.
Epstein is a terrific writer, and he makes the most of the privileged access he was granted to tell some wonderful stories about the inner workings of the entertainment capital of the world. There are detailed accounts and analyses of the remarkable deal for Arnold Schwarzenegger to reprise his role for a third time in Terminator 3, and of the scramble by Disney to save face and share in the unexpected success of Michael Moore’s Palme d’Or–winning documentary Fahrenheit 9/11 after CEO Michael Eisner had repeatedly declared that the company would have nothing to do with the controversial film. Reading these stories it is hard to argue with Epstein’s conclusion – at the end of a chapter describing how a studio can minimise its investment and risk in a film through the example of Paramount’s Lara Croft: Tomb Raider – that “things in Hollywood – and especially numbers – are not what they appear to be… [I]n Hollywood, the real art of movies is the art of the deal.”
Despite the challenges they face, and in keeping with the best traditions of Hollywood movies, there is likely to be a happy ending for some if not all of the major studios. As Epstein shows, they are extraordinarily resilient and chameleon-like in their rapid ability to change deal structures, investment partnerships, production venues and platforms to profit from the latest trends and developments. While the digital future remains uncertain as the majors remain reluctant to embrace the promise of IPTV (internet protocol television) or to dismantle the system of release windows that has served them so well and move towards simultaneous releases, one thing seems certain: if there is money to be made from filmed entertainment, sooner or later the majors will know how to make it. •
