The Economics of a Movie

One of the misconceptions I see time and time again in online forums and in the media is around the success or failure of movies based on their box office performance and their budget and therefore whether the movie actually makes any money for the producers, production company and investors (if any). I’ve also written a previous blog post called ‘Can Australian Films Make Money‘ which outlines why many Australian films don’t make money and the key attributes filmmakers should be focused on.

I must point out that there is no such thing as ‘build it and they will come’, in our case make a film, get a small distribution deal and people will come and see it. The majority of Australian films suffer from poor to non-existent marketing, unrealistic expectations about audience interest, not enough investment in marketing or poorly targeted marketing. Mao’s Last Dancer achieved $15m at the Australian box office off the back of a best selling book (existing audience) and a $2.5m+ marketing budget. Even great films like ‘The World’s Fastest Indian‘ which did extremely well in Australia and New Zealand and generated critical acclaim, can do poorly with poor distribution deals – in this case a poor U.S. distribution deal. I have outlined a detailed case study of Paranormal Activity which was made for USD$15k and earned some USD$180m at the box office through a very smart marketing strategy and campaign in one of my other blog posts ‘The Future of Filmmaking: Seizing back control of the Six Pillars of Cinema‘.

Now, before I outline a couple of detailed breakdowns of what a movie might earn and the expenses and fees associated with it (tables below), it is important to note the different distribution relationships independent producers have with the distributors:

• In-house studio production
• Negative pick-up
• Distribution agreement

In-House production

This relationship is typically engaged through a studio’s production operations. The producer provides an acceptable story, plus the capacity to complete development and deliver a finished picture on schedule and within budget. The studio provides all the development and production support, financial and business (legal and accounting) resources to complete the picture, and all the distribution resources to sell its rights. This relationship is less common, as the studios have reduced in-house development and increasingly look to independent producers to bring them at least partially developed projects.

Though the producer has creative freedom, the ultimate creative control typically resides with the studio. Also, the studio owns the negative, copyright, and all distribution rights. The producer is paid a production fee, refunded his or her development costs, if any, and typically has a net, adjusted gross or gross-profits participations in the film, commonly called points.

Negative Pick-up

This relationship is substantially more independent than studio production, and typically it is entered through a studio production unit. The producer provides an acceptable story and the capacity to complete development and deliver a finished picture and the pictures financing. The studio provides production support, a bankable contract for all or a substantial portion of the needed production funds to be paid upon delivery of the film, and license rights for global, U.S., or international distribution, as negotiated. The bankable contract typically states the studio will pay an agreed-upon amount when the film is delivered, plus royalties (a percentage of the film’s profits, according to a “net profits” definition). Negative pick-up relationships commonly allow the producer more creative freedom during the production process, though the studio may have the right to the picture’s final cut. Negative pick-ups are easier to understand and process than they are to receive, as studios have tight script, producer, and above-the-line criteria that can be challenging to satisfy.

Though it is a negotiable point, the producer typically owns the picture’s copyright, and as part of the agreement, the studio receives the distribution rights (as negotiated, consisting of global, U.S., or international rights). From the gross receipts collected by the studio, the studio is pais its distribution fee for all rights it sells, recoups its direct distribution expenses (DDEs), and may also have points in the picture.

An entertainment bank lends the producer the production financing, which necessitates that the producer have bank and completion bond relationships. The collateral provided to the bank for the production loan is typically a combination of a studio negative pick-up contract and may also include foreign pre-sales contracts and unsold territories estimated value (gap) financing. This collateral equals or excedes the picture’s negative cost, after deducting loan interest and fees. Contingency elements in the negative pick-up contract are primarily that the producer will deliver the studio access to the picture’s negative or a colour reverse internegative (CRI, created to make release prints) and campaign materials, on or before the contract delivery date, and that the picture contain preapproved above-the-line talent, including the director and principal cast. An insurance company provides the bank a guarantee (referred to as a completion bond) that the picture will be delivered within budget and by the contracted delivery date with the specified creative elements intact.

Distribution-only Relationship

This relationship typically is entered through a studio’s distribution arena. This is the most sophisticated relationship for producers to engage and delivers them the greatest overall benefits. This relationship naturally motivates the creaton of the consistently successful motion pictures, better prepares the various rights areas in the major markets, grants producers the greatest autonomy, earns the most revenues for each film, and delivers the highest profits to the producer. Typically this is the most beneficial relationship globally for audiences, studios, producers and licencees. One of the most successful production companies in this arena is Alcon (The Blind Side, My Dog Skip).

The distribution-only relationship takes many forms. Generally, the producer engages a U.S. studio or other distributor to distribute U.S. theatrical and home entertainment. In this relationship, the studio or distributor does not provide negative pickup, other financing collateral, or advance fees. The producer provides the finished picture, developed, produced, financed, and in some relationships, part or all of the direct distribution expenses (the hybrid deal). The studio’s distribution unit or other distributor provides production and campaign consulting and, most commonly, U.S. home entertainment distribution.

Although the producer consults with major market distributors throughout the development and production of the film and is license-bound to deliver the picture represented to presale participants, the producer has complete creative freedom during the production pr0cess.

The producer owns the project’s copyright and distribution rights and licenses distribution rights to U.S. and international distributors and global media. From the gross receipts, collected by the U.S. studio / distributor, the studio / distributor is paid its distribution fee for all rights it sells, recoups it direct distribution expenses, and may also have points in the picture.

Key Takeway for Producers / Film Makers

Knowing these things, before meeting with a studio or distributor, producers should thoroughly prepare, understand what they want, have in writing the deal points of a fair relationship for both sides, and should have reviewed the deal points with their entertainment lawyers. Producers are classically underprepared and underexperienced. They too often leave the negotiating table without obtaining the benefits and power they should have and with a substantially different understanding of their relationship than the documented deal points define. Contract language is precise – it is enforced in its ultimate interpretation by contract law, not by the dictionary, and though most of the language is stable, definitions can literally change daily. Producers should be prepared in every creative, business, and legal aspect relative to the production and distribution relationships they negotiate. They should expect and respect that studio and distribution executives will be excellent negotiators and impeccably well prepared.

Examples: Movie Income Comparisons

Now, let me show you an example of what a movie could earn, its expenses and how the different studio / distributor relationships impact the earnings potential for a producer. In this particular case I am using a representative example of Mao’s Last Dancer which had a reported production budget of AUD$25m and took in approximately $15m at the Australian box office. This movie did not enjoy great international distributon and marketing so the international income represents my estimate which is by no means official:

*Exhibitors in Australia generally receive around 60% of box office vs 50% on average in U.S.A.

Click on image for a clearer version.

As you can see, even when earning some $15m at the Australian box office and $13m+ in ancillary revenue in Australia, a movie with a $25m production budget would need to do extremely well across international markets to provide any financial return to the producer and production company.

Now, let’s take a look at another example, ‘Wish You Were Here’. I am assuming the production budget is AUD$3m, a P&A (Prints & Advertising) Budget of $400k, it earns $3m at the Australian box office and generates best case income from home entertainment, VOD, PayTV and Free to Air etc:

Click on image for a clearer version.

As you can see in the two examples above and the one below, the best economic situation for a producer, production company and investors is the ‘Distribution Only’ relationship but as outlined above it can have its own challenges.

In both cases I have increased the talent participation fees as most Australian movies have lower budgets and therefore can only pay small fees upfront for the lead cast so it is common to give the lead cast more participation in the success of the movie through talent participation and points (of share) allocated to the director, writers, cast, producers and others from the final Net Producers Share.

And here is a stark example of the differences in distribution options for a ‘successful’ movie with a $25m production budget and which does reasonably well in Australia & New Zealand and reasonably well internationally:

Click on image for a clearer version.

The down side of a Negative Pick-up or a Distribution Only agreement is you have to raise the budget (cash) prior to being able to put your film into production. A Negative Pick-up can be easier than a Distribution Only deal but for a producer in Australia the larger the budget the more challenging this can be. I will write another blog post specifically on financing your film along with a couple of spreadsheets which you can use to help with this process.

As I outlined in my other blog post ‘Can Australian Films Make Money‘, not all film ideas scale to the big screen and might not be commercially viable for a typical theatrical-first distribution strategy. In fact I would argue around 50% of Australian feature films released in the last six or so years would have generated more income had they adopted a VOD (Video on Demand) first distribution strategy but unfortunately a lot of our filmmakers and funding agencies are far too single minded and obsessed with a theatrical release. In fact even major studios like Warner Bros now use alternate distribution strategies featuring digital channels depending on the nature of the film property. ‘Red Cliff‘ was released to VOD before theatrical and it significantly helped the film in all channels including theatres.

Of course I am generalising but the point is that film makers must think seriously about a relevant and commercially viable distribution strategy specifically related to the characteristics and potential of their film.

Here are two good articles including examples about the growing importance of VOD for independent films:

• Wall Street Journal, ‘For Indie Films, Video-on-Demand Fills in Revenue Gap‘
• The Wrap, ‘VOD Rides to the Rescue of Indie Film‘

*N.B. The two specific examples above are for illustration purposes only. I have only used figures which have been publically reported through the media and I have estimated other income figures.

**Contributing source: The Producers Business Handbook, third edition by John J. Lee, Jr. & Anne Marie Gillen.