Tuesday, March 25, 2008

Flashback: Things I learned in Hollywood Edition


I wrote this article a year or two ago to address a break down in Hollywood's distribution driven financial model.  I read it again recently and realized many of the market forces which are creating tension in the film business today are hovering above the game industry.  I thought it was worth reviving. 

Here it is:

Hollywood started as a creator of content; it ended as a gatekeeper over distribution. While it may feel a bit early to identify the end of a multibillion dollar industry, the dream factory perceived by the outside world is long gone and without significant change, the democratization of distribution and production arising from advances in digital technology will make the US steel industry look like a growth business relative to Hollywood. But what technology takes away with one hand can be restored with the other.

In the early days of filmmaking, the producers, directors, cameramen and even talent were studio employees under contract. Over the years, through studio actions and actions of others, including the government, the contract employees went independent. The producers became independent contractors and the actors became free agents. Along the way, studios turned into content venture capitalists, placing seed investments in ideas, which if grown into something interesting, are handed off to independent contractors retained to oversee execution, which is now more often than not, outsourced to a foreign country. The exit strategy is the box office release of a film, followed by a series of subsequent distribution sublicenses – “windows” – in pay per view, cable, home video, network television, etc. The consumer dollar is not earned through the sale of the content, but through the parsing of distribution through the windows. If you want to see the film, you have to pay the party controlling the relevant channel. Much like an investment bank preselling its book in an IPO through its control of distribution, the studios presell, or predict the value of the windows. The risk capital was OPM. Doctors, energy barons, Japanese, Germans and a litany of others who all found eager recipients of financing. Life was good. Then things got digital. Like a window closing on the public market, losing the distribution chokehold killed the exit. Now the investments are starting to look like the ones no self-respecting venture capitalist will ever make, pure content plays.

The studios are not threatened by the peer to peer sharing of content they shout about, but by the Scylla and Charybdis of falling production costs and ubiquitous distribution. Studios lost the ability to internally manufacture their product when they released their costly ties to talent and focused on finance, distribution and marketing. Studios are now merely go betweens for financing and the distribution and marketing is losing significance.  As technology opens more cost effective distribution channels, the large audiences aggregated through broad marketing campaigns are no longer a necessity. The studios reasons for being come into question. Is it any wonder each studios is reducing its output?

When I was at the agency the head of a studio presented a grand and very important speech.

“Stealing music is wrong.” He proclaimed, ”People should not download music on peer to peer networks.”

I wholeheartedly agree. I bought my house with money generated under the umbrella of copyright. Owners should be paid.
"Stealing movies is wrong."   He continued.  Hazzah we replied. 

“Consumers are Tivoing through commercials place in our prime time line up. They are not obeying the contract.”

Whoa, wait a second there. You had me on the first two, but you lost me on the third. I don’t remember agreeing to watch 8 minutes of commercials for every 30 minutes of network programming. There is no contract. The studio head was clearly upset, but for the wrong reason. He was not concerned about a lack of interest in his content he was upset the public was not accepting the package. 
Prior to peer to peer and iTunes, the record companies could put enough filler on a CD to charge people $15.99 to purchase the one song they heard on the radio. Prior to Tivo the networks broadcast a show, and if you wanted to see the show, you had to sit through the commercial. Now people pay extra money to avoid commercials. The public is actually paying more money than ever before for its content, but it is not going to the studios. Equipment and subscriptions like Tivo and iPod capture the money which would otherwise go to studios. If the studios are to stay in business, it is incumbent upon them to figure out how to capture the dollars flowing into the market. Right now, they are looking in the wrong place.

The Vice Chairman of one of the studios called me in for a meeting. I didn’t know why, but I went because he was the Vice Chairman of a studio and I was still at the agency. I thought he wanted to talk about games.  After all, it is what I do. He started the meeting with “How do your clients feel about pirated films?”

“I really don’t think they put much thought into it, my clients make games.” I replied.

“Games are technology. You know about technology. Your actor clients, the agency’s actor clients. How do they feel about it?”

“Well, I certainly can’t speak for the agency or its clients, but it seems to me that if you pay an actor $20 million for a film and they don't have a gross participation, they really don’t care whether people in China pay you or the pirates.”

“Well they should, and we have to shut the pirates down before we turn into the music business.”

After so many years of profiting from an inefficiency in the supply chain, the industry forgot how to make money on its product. The industry must focus on adding value, not closing down distribution. While it stands like the little boy with his finger in the dyke, trying to reestablishing the inefficiency, others are finding ways to entertain the public. Television viewership, box office and DVD sales were all down last year. Internet usage, online purchases, video game and home theater sales were all up.

The technology industry has the answer Hollywood chooses not to listen. Hollywood says “I am going to make something, and you are going to pay me to pass through the toll gate and see the content.” Technology says “I am going to give you something, and then I am going to add enough value for you to want to pay for it.” The difference arises from each industry’s dna. Unlike Hollywood, where people paid for access to content from the start, software was given away for free. Bill Gates wrote an open letter to the industry telling them they should charge for their work and people got mad. As we all know, companies moved to payment model, but the seeds for value based pricing were sewn. If I buy an Oracle seat, I pay for the license, but Oracle profits from my service contract. If I download a Quake demo and like it, I pay to get the whole thing. Payment for services and value that cannot be pirated.

Steve Jobs introduced value in the form of context. He proved people will pay for a guaranty of receiving the song they want, when they want it, and where they want it. Next he showed, people will pay to receive a television show, which is also available for free, so long as it is in the format and at the time they choose to view it. In doing so he dragged the television industry, some say by accident, into a new revenue stream. The consumer is paying for the option of selecting the package. While this flies in the face of the business model espoused by our studio friend above, it provides an opportunity for him to capitalize on his library of content and potentially his new content, while actually making more money on a per viewer basis than first run broadcast. iPod did ok prior to content distribution on iTunes. It exploded after the introduction of content. This is great news for Hollywood.

Pixar makes great movies, and when coupled with Disney marketing, they perform exceedingly well. Hollywood has libraries of desirable content, and despite jettisoning all its employee talent; the execution and oversight talent still resides largely, and for a short period, uniquely in this city. The studios will clearly not figure out the new business models on their own. They need the help of the technology business. The reception should be welcome, as the technology business learned years ago that people buy hardware for what you can do with it, not the hardware. The industries need each other and the digital revolution brings them closer together than ever before. So after all these years of false starts and unhappy marriages, can’t we all just get along?



2 comments:

The Commish said...

“Well, I certainly can’t speak for the agency or its clients, but it seems to me that if you pay an actor $20 million for a film and they don't have a gross participation, they really don’t care whether people in China pay you or the pirates.”

Brilliant in its simplicity.

Don DiPietro said...

I enjoyed this when I read it last year and I enjoyed it more now. The thing to realize is that the market shift you describe is still happening. iPod/iTunes is not the endgame. It's just less inefficient than the models it replaces. Buying an episode of The Office on iTunes is less inefficient than waiting for the re-run, or the DVD. But iTunes is still not an efficient market; certainly not from an economist's perspective.

Consider this: I have two songs on my iPod that I purchased for a buck each from iTunes. I listen to one song five hundred times and the other song once. In the first case, the artist is getting ripped off, in the second, I'm getting ripped off. This is not an efficient market. A purely efficient market mechanism is coming and it will be based on the dreaded "C" word...

As these doomed experiments in DRM, subscription, etc. fall by the wayside, the entertainment industry will end up as a truly commoditized marketplace. I will pay for the seconds of entertainment that I consume and the proceeds will be distributed back to the rights holders in the most equitable manner possible. Talented creators will be rewarded by more revenue. Less talented creators with less revenue. It's not that difficult -- or far-off -- an inevitability to consider.

When this happens, our viewing (and listening, and gaming) habits will be measured by micro-usage -- much the same way we purchase electricity today.


And, hey. Anyone who can cite Scylla and Charybdis in a blog is worth reading again and again.