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Media Production
Feb 13, 2011
(Based on Powerpoint Version 123A)
Media Production
I. I. THE PRODUCTION PROCESS
1. Introduction
A. The Business of Content
2. Content Production
A. Overview
1. Techniques for Discrete Projects (“Job Shop”)
1. Gnatt Chart
2. CPM - Critical Path Method
3. Pert Chart
2. Continuous Production Process (“Flow Shop”)
1. Linear Programming
2. Operations Research Techniques
B. Special Characteristics in Content Production
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3. Case Discussion: The Hollywood Advantage?
4. History and Development of Content Industries
A. Early Content Industries
1. Distribution Cost: Film vs. Theater
2. Break-Even Point
B. Development of the Film Production Industry
1. Movie Technology
2. Content Models
C. Business Models Content Production in Publishing, Music,
Games, Television, and Theater
1. Book Publishing Industry
2. The Music Industry
3. The Theater Industry
4. Television Production
5. The Video Game Industry
6. Software Production
5. Content Production Worldwide
II. CONVENTIONAL ARGUMENTS FOR HOLLYWOOD’S SUCCESS
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1. Market Size?
A. Model: Small Country vs. Large Country
2. Political Power? “Cultural Imperialism?”
3. Vertical Integration of Content with Distribution
A. Distributors
B. Reasons for Vertical Integration
C. Advantage of Vertical Integration: Control Over Release
1. Theatrical Release
2. Release Timing
3. Basic Principle for Release Sequence Strategy
4. Video Release Sequencing Model
D. Vertical Integration: Wholesale Distribution - Retailing
E. Disadvantages of Vertical Integration
F. Vertical Integration In Other Media Industries
G. Conclusion on Vertical Integration
4. Stars
III. SUCCESS FACTORS IN CONTENT PRODUCTION
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1. Organizational Structure
A. Specialization
1. Animation Technology
B. Management
1. Talent Agencies
2. Independent Producers
3. Distributors (Studio)
2. Reduction of Risk
A. High Failure Rates
B. Selection of Lower-Risk Projects
C. Risk Reduction: Step-Wise Investment (Option Contracts)
D. Content Portfolios and Diversification
E. Conclusion
F. Conclusion on Risk Reduction
3. Funding
4. Conclusion on Large Budget
IV. PRODUCTION DEVELOPMENT AS A KEY FACTOR
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1. Concept Creation (Style)
A. Modeling Content Production Choice
1. Mass Market
2. Niche-Driven Content
B. The Midas Formula for Blockbusters?
C. Product Selection
1. Content Selection Process
2. Content Development Process
3. Selectivity
4. Screen Functioning
5. Selectivity of Manuscripts
6. TV Program Selection
7. Statistical Tools for Product Selection
D. Further Development
1. Script Writing
2. Content Innovation
3. Production Differentiation vs. Market Innovation
4. Market Testing
2. Product Planning
A. Operational Challenges for Content Production
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B. Operations Management
1. “Scientific Management”
2. Tools for Operations Management
a. Techniques for Discrete Projects (“Job Shops”)
b. Continuous Production Process (“Flow Job”)
c. Linear Programming
d. Operations Research Techniques
e. Quality Control
C. Post Production
3. Productivity
A. What is “Productivity?”
B. Productivity in Film
C. Content Production in the Next Generation of Technology
1. Content Model: Immersive Film/Game
2. Content Model: Adult Applications
3. Content Model: Marketing
4. Content Model: Travelogue
5. Content Model: News
V. CONCLUSION: WHAT WORKS FOR CONTENT PRODUCTION
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1. Tools
2. What Does It Take for Success in Content Creation and Production?
3. What Do We Deduce to be the Elements of Success for Commercial Content
Production?
A. Risk Reduction Techniques
B. Product Development
C. Organizational Structures
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Appendices
Appendix A: How to Review a Technological Claim?
Appendix B: R&D Organizations
Appendix C: CTO Responsibilities: Organize the R&D Lab
Appendix D: Matrix R&D Structures
Appendix E: Managing the Globalization of Corporate R&D
Appendix F: Standards Strategies
Appendix G: Consumer Electronics
Appendix H: Consumer Electronics R&D
Appendix I: Disruptive Technologies
Appendix J: Production
Appendix K: New Generation Networks C“NGN“s
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Production of Media Content
I. THE PRODUCTION PROCESS
“Stories. We have always told them to each other. Stories that comfort,
that surprise, that entertain. There have always been storytellers sitting by the
hearth, traveling from town to town, speaking, writing, and performing
narratives of loss and redemption; of heroism; and of failure. Stories that both
manifestly and secretly offer models and morals routes to the past and future;
guides for the perplexed. Stories that challenge, tease and undermine.”
-Roger Silverstone1
This is what this chapter is about: the creation of stories, in a big way, in an
industrial way, in a post-industrial way. We call it the production of content; an
industrial age term--production; a post-industrial, information-age term--content;
and the production of the devices to tell those stories.
1 Silverstone, Roger, “Why Study the Media,” SAGE Publications, 1999
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I.1. Introduction
The media sector has three legs: content, distribution, and devices. This
chapter will address content, specifically its production. We will address the
following questions:
• What are the ingredients of successful content production?
• How is content production being organized on an industrial scale?
• What management tools can be applied to content production?
A. The Business of Content
When it comes to media content – movies, TV shows, music, books,
newspapers – it seems that everybody is an expert. It has surrounded us since birth
individually, and surrounded us collectively as our culture. Media content is not
merely art and entertainment. It is also a world-wide role model, a trend-setter, a
mood setter; media content exerts influence on our values, our attitudes, our
politics, and our lifestyles. It is the subject of intense public fascination and
scrutiny.
It is also an industry, and for the U.S., among the largest export industries.
11
Creativity is thought of as an individual activity, but it has become an
organized business and understanding social activity. Film, theater, opera, and
software development are all the result of collaboration and teamwork. Creative
content is being created on an industrial scale – the “Dream Factory.” It is a
complicated process. F. Scott Fitzgerald, himself with some Hollywood
experience, wrote in his final novel, The Last Tycoon, “not a half dozen men have
been able to keep the whole equation of pictures [film] in their heads.”
Take the total video program hours per week provided to New York TV
viewers: 1,016 hours in 1969, increasing ten-fold to 9,600 hours in 1997, and
almost tripled again further to 25,000 hours by 2011, (not including the countless
hours of internet-based TV). Such vast content provision requires an equally vast
production system.
I.2. Content Production
A. Overview
How do companies, whatever their business, manage their production process? In
general, production requires the following:
• Preliminary selection
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• Product design, testing, and approval of product
• Funding of process
• Production process planning
• Procurement of inputs
• Deployment of work force and of equipment
• Testing and fine-tuning
• Physical production of components
• Assembly of parts
• Quality control
• Release of product to distribution.
•
In many ways, the production of content is similar to the production process
of manufactured goods. Each of these steps, functions, and processes types exist
also for content production.
Production is generally done in either of two basic ways – as a “job shop” or
as a “flow shop”. Generally, a job shop is a craft production. Craft productions are
often the manufacturing on a small scale. A job shop process creates special and
highly varied products and uses general tools. It is highly flexible, and the products
are relatively few. In the media field, examples for job shop productions are
13
motions pictures, music recordings, plays, and book publishing. Job shop
productions typically require limited capital investment to cover the relatively
moderate upfront fixed costs, but have high marginal cost of production for the
individual item
In contrast, a “flow shop” is a continuous process of mass production that
requires specialized resources. Flow jobs tend to be industrial productions, which
are on a larger scale and repetitive. It is characterized by high fixed costs but low
marginal costs. It is less flexible than a job shop production in that flow shops
require larger capital investment. On the other hand, a flow shop. examples of flow
shop productions are newspapers and magazines in content, and
telecommunications services in distribution.
An intermediate category is a “batch” flow of production, which creates a
small set of similar products. A TV series is a an example.
The graph below illustrates the cost characteristics of craft vs individual
production. Craft production requires a relatively low fixed cost and (Co) its
average costs are therefore moderate during the earlier stages of production
(Quantity of Production B1); but increases in such production add a substantially
marginal cost which means that average costs do not drop much (and may
eventually increase.) Industrial production, in contrast, starts with a much higher
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average cost due to the high initial fixed cost (C1). But since, it enjoys lower
marginal costs, average cost eventually is lower than for craft production. (B2).
1. Techniques for discrete projects (“Job Shop”)
Uses for discrete projects can be seen in the following charts.
1. Gantt Chart: A Gantt Chart displays, in a timeline format, how a project
develops.
15
2
2. CPM – Critical Path Method: A Critical Path Method chart also displays a
timeline of the project development, but additionally prioritizes the different parts
of the project.
3
2 "Gnatt Chart." NetMBA Business Knowledge Center. Internet Center for Management and Business Administration, Inc., 2010. Web. 07 July 2010. <http://www.netmba.com/operations/project/Gnatt/>.
16
3. Pert Chart: A Pert Chart shows what tasks need to be finished to complete a
certain goal, and approximately how long it will take to finish them.
4
Other Production Analysis Tools:
3 "CPM Chart."Dr.Dobb’s, the World of Software Development”, PERT: Precursor to Agility, 01 February 2004. <http://www.drdobbs.com/184415094> 5 "PERT Chart."Wikipedia”, PERT Graph with critical path. <http://en.wikipedia.org/wiki/File:5n_PERT_graph_with_critical_path.svg#file>
17
FMEA (Failure Mode and Effect Analysis) is a way of analyzing the potential
ways a certain task can fail.5
Six Sigma is a methodology that helps to reduce the amount of errors in a business
model. 6 These defects correspond to the following percentages. The higher
percentage is reached by +/- Six Sigma, which helps to reduce the amount of error
in the business model.
5 "Failure Modes and Effects Analysis (FMEA) - ASQ." American Society for Quality - ASQ. Web. 07 July 2010. <http://www.asq.org/learn-about-quality/process-analysis-tools/overview/fmea.html>. 6 Tennant, Geoff (2001). SIX SIGMA: SPC and TQM in Manufacturing and Services. Gower Publishing, Ltd.. p. 6. ISBN 0566083744.
What are the potential effects of failure modeIdentify Failure ModesHow could we detect the
course of failure
How serious are those effects?Identify Potential CausesControl plan
SeverityOccurenceDetection
Define Requirements and Expected Outcomes
x x
Risk Priority Number
If Risk Priority Number is > 125 action has to take place.
18
MRP (Manufacturing Resource Planning) systems are used to organize the
resources in a production.7
2. Management Tools for a Continuous Production Process (“Flow
Job”)
1. Linear Programming
Linear Programming is a technique for solving some operations management
problems. Linear programming models use an algebraic linear expression that
defines the production as an objective function that must be either maximized or
7 "Manufacturing Resource Planning (MRP II)." Investopedia.com - Your Source For Investing Education. Web. 07 July 2010. <http://www.investopedia.com/terms/m/manufacturing-resource-planning.asp>.
-6σ -3σ -1σ +1σ +3σ +6σ 99.9997%
99.9999998%
Target
t
Value
Value
19
minimized, and use other equations (or inequalities) as the constraints on that
function.
A variant is nonlinear programming when one does not have linear
expressions defining the objective function or constraints of an optimization
model. In general, however, a nonlinear programming model is much more
challenging to solve than that of a linear programming model. 8
2. Operation Research (OR)
Operation Research (OR) is a collection of mathematical and statistical
techniques for the decision making and management tasks. Linear programming
generally ignores the effects of uncertainty, instead assuming that the results of
decisions are predictable and easy to foresee. Operations research tends to
incorporate stochastic elements and recognizes uncertainty through the use of
random variables within some aspects of the problem. 9 A sub-area of operation
8 Jensen, Paul A. "Nonlinear Programming." The Mechanical Engineering Department at the University of Texas at Austin. University of Texas, 2004. Web. 22 June 2010. < http://www.me.utexas.edu/~jensen/ORMM/models/unit/nonlinear/index.html >. 9 Jensen, Paul A. "Stochastic Processes." The Mechanical Engineering Department at the University of Texas
20
research is queuing theory, which is a mathematical study of waiting lines, or
queues. The theory permits the derivation and calculation of multiple performance
measures, which include the average time spend waiting in the queue, the total
number waiting/receiving service, and the chance of people abandoning the line
and giving up. This enables an optimal deployment of resources. Examples for
queues:
• Callers for a cell phone service representative
• Installation orders for cable TV
• Scheduling of artists in recording studio
B. Special Production Characteristics of Content
There is an unusually high level of uncertainty about the success of content
products, especially when it comes to discrete products, about commercial and
critical success.
Products have high fixed production costs and low reproduction costs.
Discrete products require significant upfront capital to make the initial product.
at Austin. University of Texas, 2004. Web. 22 June 2010. <http://www.me.utexas.edu/~jensen/ORMM/models/unit/stochastic/index.html>.
21
There often exist content producers who do not maximize of profit, which
changes the nature of competition.
Media content has often public good characteristics: its value for beyond the
immediate benefits to the producers Non-excludability and non-rivalry of
consumption.
Network effects: the users of a product affect the value of that product to other
users.
Excess supply: production exceeds demand.
I.3 Case Discussion: The Hollywood Advantage?
In order to understand the success factors for content production, we will
explore the following question: Why has one particular content production center –
Hollywood – been so successful, for so long, in so many countries, and potentially
now the Internet? And this despite the fact that Hollywood is a high-cost producer;
that it has usually lacked a strategic vision (it initially totally missed the
significance of broadcast TV, cable TV, home video, and the Internet).
Yet none of this seems to have made a difference. Hollywood productions
have remained predominant around the world for nearly a century, and, despite
22
many efforts, despite countless restrictive rules and regulations dating back to the
beginning of the 20th Century, even before World War I and the rise of the United
States as a superpower, little has changed. In 1920, the Hollywood studios
accounted for over 70% of world’s movie revenue. In 2010, then still maintain
about the same market share. During this time, pretty much the same six firms
(Universal, Paramount, Disney, Warner Bros., Columbia, 20th Century Fox)
dominated (MGM and RKO dropped out, while Disney was added) and produced
the majority of films.
Not even Houston’s oil companies, New York’s Wall Street financial sector,
or Detroit’s automotive industry maintained such a long-term global dominance.
What does this tell us about the elements for success in content production?
Case Discussion: Canal Plus (Canal+) and Mukta Arts vs. Hollywood
10
Canal Plus, a subsidiary of French media giant Vivendi, is a highly
successful pay-TV company with its own production arm, known as Studio Canal. 10 Photograph. PlainStuff.net. Web. 22 May 2009. <http://www.plainstuff.net/Movies/details/DCimages/Studio/StudioCanal.gif>.
23
It has distribution channels in France, Europe and Africa and holds a stake in most
French film productions. As Europe’s largest film distributor (over pay-TV) and
film producer, it wants to export content worldwide.
Mukta Arts, a major Indian film producer, has a built a large distribution
network and library of films within India. It, too, wants to reach markets. How can
Canal Plus and Mukta Arts become global content producers?
I.4. History and Development of Content Industries
1. Early Content Industries
The production of what we now call “media content” goes back to the dawn of
humanity, when individuals and groups performed for their community or
overlords. Over time, this became organized and institutionalized-- theater in
ancient Greece, gladiator spectacles in Imperial Rome or, playhouses in
Elizabethan London. Some performers were individual content providers, such as
bards, troubadours, balladeers, and minstrels. Others were teams organized as
24
content companies that produced and performed spectacles, plays, music events,
and operas.
In America, popular enterntainment was provided by vaudeville and
burlesque shows. But the economics were unfavorable – they were relatively
expensive to produce, special effects were difficult to create, and the limited
potential for automation and mass production meant it was difficult to expand
performances to larger audiences. These craft system of content production and
distribution were ready to be replaced by a more industrialized model, and one
emerged at the turn of the 20th century as film. Film’s cost of distribution to
another viewer is only 1% of the cost of the theater to do so. This enables a
vendor’s distribution to a much larger audience than before.
Fixed Cost
(Content)
Production/Sec
Marginal Cost
(Distribution)
cost/cap/sec
Theater $25 0.56¢
Film $10,000 .005¢
It facilitates low-cost distribution to audiences of many millions. On the
other hand, to make millions of people want to see the production over the
production of others forces producers to create more attractive content. This means
25
that the upfront cost of producing the film is much higher than those of theatrical
shows. Content production costs of film (the fixed costs) have thus risen over time
to a remarkable $10,000/sec, 500 times higher than for theater in 2011. A 90-
minute Hollywood film cost averages 54 million dollars. Thus, film shifts costs
away from variable costs of distribution to fixed cost of content production. The
cheaper the distribution becomes, the more elaborate the content production can
become since it is spread across more uses. Thus the viewer can watch a more
basic inexpensively produced show and pay less. And it is one o the economic
characteristics of an industry with high fixed costs and low marginal costs that it
has high economies of scale – large providers have cost advantages over small
ones, (as long as they produce reasonably efficiently).
1. Break-Even Point
A “Break-Even Point” of a production occurs when total costs of the
production equal total revenue. These costs go up with the number of viewers,
showings, buyers or performances. The equation below shows how to determine
this break-even quantity. If a firm can sell a product at a quantity that is higher than
the break-even point, it will make a profit: below this point, it will face a loss. The
breakeven point is found where:
26
TC = TR (Total Cost = Total Revenue)
TC = FC+VC·Q (FC= Fixed Cost; VC= Variable Cost; Q= Quantity of production)
TR = P·Q (P = Price) ,
After substitutions, we find that ! = !"!!!"
= Breakeven Point
Example: Let us assume that a theater that has an average net ticket cost of $40,
fixed cost of $300,000 ($130,000 for content marketing and overhead). It performs
5 shows per week, each time for 400 audience members. The cost of serving each
audience member is $30. The breakeven will be at an audience of 30,000. We
arrive at this number using the break-even equation:
! = !"!!!"
= Breakeven Point
This number is reached after 15 weeks.
Compare this with the breakeven point for film whose ticket price is $12.
The producer/distributor gets to keep its 50% share of box office money, and
marginal revenue (P) is hence $6. Fixed costs are $77M (content $54M, marketing
and overhead $23M) and there is a variable cost of $.27 per ticket. The breakeven
point can be calculated as follows:
000,303040000,300
=−
=Q
27
The film is screened in 1,000 theaters with 20 weekly showings and an
average audience of 200 audiences per screening.
The weekly audience is 11 million, and the revenue is $24 mil. Breakeven
at 13.4M tickets is reached in week 4.
In our example, the film, despite its high total production cost ($54M) and
high marketing cost($23M) (vs. 130K and $170K for theater), has a lower average
cost per audience after 1.5 million viewers, because it can be spread across a wider
audience.
The same cost dynamics apply to a comparison of printed books with hand-
written manuscripts. Printing press reduces incremental cost, but increases upfront
investment in fixed cost, which can be spread over more copies. The same cost
dynamics also applies to recorded music versus live music, or software off-the-
shelf package versus customized programs. It is the dynamics of an industrial mass
production versus an artisan production.
It is a double-edged sword. Production with a higher fixed cost and lower
marginal cost is more profitable when the number of tickets sold is large.
610,424,1327.6000,000,77
=−
=Q
28
Conversely, it can also lead to a much higher loss when the number of tickets sold
is low. It is the higher risk production strategy. To deal with the downside, risk-
reduction therefore becomes a central management task in content production.
A second consequence is that a high-fixed cost, low marginal cost industry
will exhibit high economies of scale and consequently a more concentrated
industry structure.
2. Development of the Film Production Industry
1. Movie technology
In the 18th century, the recognition of a “Persistence of vision” (i.e. the blurring
of images into each other when they pass the eye rapidly) led to novelty items,
such as Zoetrope, which created simple moving images. 11
11 vlado.fmf.uni-lj.si/sola/1995/anima/anim21.htm
29
In the 1820s and 30s, Nicéphore Niépce and Louis Daguerre in France, and
William Fox Talbot in England invented the process of photography, using glass
plates.
In the 1880s, George Eastman introduced celluloid film and cheap Kodak
cameras in the United States.
In 1891, Thomas Edison’s R&D laboratory invented the Kinetoscope, a kind of
peep display, and the Kinetograph, a camera system. This was augmented by the
30
Kinetophone, a sound system based on Edison’s cylinder phonograph. Edison’s
first copyrighted film The Sueeze was copyrighted in 1893.12
Edison’s peep display could be viewed only individually or by small groups
using a bank of consoles. In contrast, the brothers Louis and Auguste Lumière of
Lyon, France projected their moving images onto a screen. The first film show was
in Paris in 1895.
Louis and Auguste Lumière
Their first film was L’Arrivée d'un train à la Ciotat (1895)
Almost immediately, new types of content began to emerge. In 1902, A Trip
to the Moon, a science fiction film, was produced, introducing special effects.
12 http://memory.loc.gov/ammem/edhtml/edmvhist.html#0)
31
13
At the same time the first Western film, The Great Train Robbery was
created.
These and others could venture into content that theater could not do –
special effects and genuine outdoor scenes. They did so at a relatively high cost,
because the new medium has changed the economics of content creation to one of
higher upfront costs and lower distribution cost.
These fundamental economics led also to incentives of piracy, and imitation,
and to attempts at market concentration. The “Edison Cartel” pooled in 1908 the
patents of the industry leaders Edison, Pathé, Vitograph, Eastman Kodak,
Biograph, and J.P. Morgan in an attempt to control the industry. The cartel had
patents, lawyers, theaters, money, and connections. Even so it was unable to
suppress independent film entrepreneurs from the vaudeville theater industry.
These early film entrepreneurs included such legendary figures as Mack Sennett,
13 http://www.moma.org/collection/filmvideo/pages/melies.trip.html
32
Harry Cohn, Adolph Zukor, Marcus Loew, William Fox, Carl Laemmle, Jesse
Lask; the Warner brothers, Louis B. Mayer, and Sam Goldwyn. Later, in the
1930s, Walt Disney joined. Together, they established the film companies which
exist into the 21st century The new entrepreneurs soon moved from New York to
Southern California for its weather which made outdoor shooting simpler. Other
factors were the lower costs of non-union labor, and the greater distance from J.P.
Morgan’s New York lawyers and friendly judges.
As the industry grew, each studio organized a factory-like production
facility, with actors, directors, craftsmen, crews, and equipment that could be used
for many projects. They moved into a flow-type production, creating hundreds of
films each year.
The MGM studio in Culver City could produce six different films at the
same time. Its assembly-line facilities enabled feature films to be shot in one to
three weeks. “B” films were often shot in a week or less.14 Cecil B. DeMille at
times directed and produced two films simultaneously.
Universal Studio Lots
14 Epstein, Edward Jay, “The Big Picture, The New Logic of Money and Power in Hollywood,”
33
The six major Hollywood studio films that dominate the film business have
fairly similar market shares of 10-20%, depending on the success of a particular
season.
Before we continue discussing film production, let’s look briefly at other
content production industries.
3. Content Production in Publishing, Music, Games,
Television, and Theater
1. The Book Publishing Industry
Early printers functioned as publishers dealing with content; they were often
unqualified for this responsibility. Printing centers emerged, such as Venice,
Leipzig, Frankfurt, Paris, and Antwerp.
In the early 18th century, publishing separated from printing getting
professionalized. Some of these publishers such as Weidmann (Leipzig) and
Longmans (London), have continued their publishing activities into the 21st
century.
34
In the US book industry, the industry structure stabilized in the 1920s,
centered on major publishing firms, such as McGraw-Hill, Simon & Schuster,
Little Brown, MacMillan, later Grolier and Random House, mostly located in New
York. The book industry has fairly high marginal costs but moderate fixed costs;
its economies of scale are not very high. This has contributed to the book industry
with numerous small publishers, and to a huge number of individual products,
most with a small production run. Combined with the rising supply of authors, the
number of titles published has grown strongly. There is no agreement of what a
“book” is. Using different definitions, the average annual number of new titles for
the US is about.15 In Germany, about 90,000 book titles were published in 2008. In
the UK. In China. And in India
In the US, the market share of the largest publishers was, in 2007:
Scholastic 0.9 %
Rippleswood Holdings (Reader’s Digest) 1.3 %
Holtzbrinck (Germany) (MacMillan, St. Martin’s,) 2.6 %
Lagardere/Hachette (France) (Grolier, Time Warner, Little Brown) 3.4 %
Reed Elsevier 4.1 %
Pearson (UK) (Penguin, Viking, Addison Wesley) 5.2 %
Viacom (Simon & Schuster) 5.2 %
15 Who Owns the Media, Benjamin Compaine,1st ed.; International Publishers Association www.ipa-uie.org/
35
News Corp (Harper Collins, Scott & Foresmann) 7.1 %
McGraw-Hill 8.9 %
Bertelsmann (Germany) (Random House, Bantam, Dell, Doubleday) 10.4 %
Others 50.9 %
Italics: part of major media conglomerate.
While major media companies (many of them from other countries) has
shares in the total book market, about 3,000 other book publishers shared more
than 50 % of the total book market in the United States.
In Europe, the major book publishers have high market shares in trade and
paperback books. In France, Hachette/Lagardere has 32%; in Italy, Mandadori has
30%; in the UK, Random House (Bertelsmann) has 13%, and the same company
has 11% in Germany.16
There is a strong role in global book publishing by non-American companies
such as Bertelsmann (Germany), Holtzbrinck (Germany), Pearson (UK),
Holtzbrink (Germany), Keuwer (Netherlands), and Reed Elsevier (Netherlands).
Of a book’s retail revenues, the following are recipients’ approximate
shares:
16 Source: Financial Times Deutschland, 3/02/2003
36
1. Retailer – 45%.
2. Author’s Royalties –15%.
3. Wholesaler –10%.
4. Publisher –12.7%.
5. Printing –10.1%.
6. Marketing –7.2%.17
Newspaper Production
Magazine Production
2. The Music Industry
18
17 http://ireaderreview.com/2009/05/03/book-cost-analysis-cost-of-physical-book-publishing/ 18 Lion Recording Services Inc. http://www.lionrecording.com/cds.jpg
37
The recorded music industry is internationally concentrated and integrated
with other media. The four major music groups own a large amount of specialized
labels worldwide.
The music industry has low economies of scale and entry barriers on the
content production end, but high economies of scale on the distribution end, where
only a few companies exist.
The business model for the music industry, however, has been changing
drastically. Technology has shifted from music as a physical product, such as vinyl
records or CDs, to electronically stored and distributed files and formats, such as
MP3s
Apple’s iTunes store, in particular, revolutionized music business by
abandoning the physical CD in favor of downloads.
There exists also a major element of licensed downloading and copying of
music. File sharing websites, such as Napster and Kazaa, enabled peer-to-peer
sharing.
A typical CD’s retail price consists of the following components:
• Retail overhead: 24.3%
• Retail profit: 5%
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• Distribution cost: 5.6%
• Musicians' unions: 1.2%
• Packaging/manufacturing: 5%
• Publishing royalties: 5.1%
• Artists' royalties: 10%
• Marketing/promotion cost: 15%
• Label overhead cost: 18.2%
• Label profit: 10.6% 19
3. Television Production
The U.S. market share of major production companies for prime time TV
shows in 2006:
TV Show Production (U.S. Prime Time) (2006)
TV companies Percentage of Hours NewsCorp (Fox) 18.7% Disney 18.7% Viacom (Paramount) 14.6% Time Warner 10.4% GE (Universal) 10.4%
19 Aylward, Kevin. "Does a CD Have to Cost $15.99?" Web log post. Wizbang. 14 Oct. 2004. Web. 29 June 2010. <http://wizbangblog.com/content/2004/10/14/does-a-cd-have.php>.
39
Endemol 8.3% Sony 4.2%
4. The Video Game Industry
The three main types of game developers are third-party developers, in-
house developers, and independents.20
Video game titles have an 80% failure rate. Major games, on average, cost
$10 million to produce and another $10 million to market, and are created by teams
of 10–to-100 people. Games are subject to 5 year hardware cycle, which forces the
companies to essentially redo much of their game software every five years.
In November 2009, a single video game, Call of Duty: Modern Warefare 2,
developed by Infinity Ward and published by Activision, sold over 4.7 million
copies in the first 24 hours in just the U.K. and the U.S., earning roughly $310
million dollars.21 Its first weekend, the game earned over $550 million worldwide,
surpassing the movie The Dark Knight’s $155 million opening weekend and Harry
Potter and the Half-Blood Prince's $394 million five-day earning. 22 By January
2010, the game had earned over $1 billion from over 25 million unique players. 2324
20 https://en.wikipedia.org/wiki/Video_game 21 Gaylord, Chris. "Modern Warfare 2 Sales Nuke All Previous Records." The Christian Science Monitor. 12 Nov. 2009. Web. 07 July 2010. <http://www.csmonitor.com/Innovation/Horizons/2009/1112/modern-warfare-2-sales-nuke-all-previous-records>. 22 Magrino, Tom. "GameStop Q3 Profits Hit $52 Million, Modern Warfare 2 Sets Record - News at GameSpot."
40
5. Software Production
Major Video Game Software Makers (Market Share by Revenues), 2007
2007 Electronic Arts 16.5% Activision 8.8% Microsoft 8.2% Nintendo 9.3% Sony 7.5% THQ 4.0% Ubisoft 3.9% Konami 1.6% Other 36.7% US. Total Revenue ($ mil)
8,640
25
Commonalities of Content Production
I.5 Content Production Worldwide
For several centuries, the flow of culture – books, theater, and music –
flowed largely in one direction out of Europe: to the colonies and the rest of the
world. But then, the direction of the flows was reversed for the young medium of
GameSpot. CBS Interactive, 19 Nov. 2009. Web. 07 July 2010. <http://www.gamespot.com/news/6240854.html>. 23 Wilson, Mark. "Avatar vs Modern Warfare 2: Billionaire Earnings Fight!" Gizmodo, the Gadget Guide. Web. 07 July 2010. <http://gizmodo.com/5448979/avatar-vs-modern-warfare-2-billionaire-earnings-fight>. 24 Hinkle, David. "Modern Warfare 2 Enlists 25 Million Unique Players, Bowling Says." Joystiq. 9 Mar. 2010. Web. 07 July 2010. <http://www.joystiq.com/2010/03/09/modern-warfare-2-enlists-25-million-unique-players-bowling-says/>. 25 Company Reports; NPD Group (2007); Wikiinvest.com/industry/video_games; iSuppli Corporation, 2007 report; Edgaronline.com "Top 20 Publishers, 2007"
41
film. In the early 1920s after World War I, American films accounted for nearly
three quarters of the box office in Europe.26 Protective import quotas restrictions
on the repatriation of box office earnings were speedily established in the major
European countries. Content protectionism serves three functions: to shelter a
country’s national culture and identity; to support the influential cultural
production sector, and its work force; and to help project a country’s visibility
worldwide. Its policies are direct governmental subsidies, import quotas, screen
and broadcast quotas, and tax breaks. In Canada, the government subsidizes film
production directly, and 60% of the Canadian TV schedule must be Canadian
content. In Australia, government money makes up around 37% of overall
investment, along with the lost tax revenues from an immediate 100% tax
deduction for investors. In Europe, Brussels at some point subsidized $850 million
in a year for films that generated box office revenues of only around $400 million.
On top of these EU subsidies, most European countries also have their own
subsidies, some of which are over 50% of a film’s budget. But even so, the top 40
grossing films worldwide in almost every year were nearly all American
productions.
26 Epstein, Edward Jay, “The Big Picture, The New Logic of Money and Power in Hollywood,” New York: E.J.E. Publications, Ltd., Inc., 2005
42
In most countries, audiences prefer domestically produced films. But
imported Hollywood films follow behind as second most popular, and they are
more numerous. The key demand problem is that films from third countries –
including films from neighboring countries – are much less popular. For instance,
only 8% of film revenue in Europe is from European films shown outside their
own national market in other European countries.27
What then are the reasons for Hollywood’s success as a content production
center? The answers may help to identify the main success factors for content
production more generally.
II. CONVENTIONAL EXPLANATIONS OF SUCCESS FACTORS IN CONTENT PRODUCTION
Japanese N/A 130 1.2
German 95 110 3.2
Wu Chinese N/A 100 .7
Korean N/A 80 .9
(No reference)
27 Focus 2004, World Film Market Trends, European Audiovisual Observatory, 2004
43
The conventional argument for content success is that a large domestic
market must exist before exporting the content. But such “two-stage” thinking in
which exports are only a subsequent strategy, makes no sense for a business firm.
With such economic logic there would be no watch industry in Switzerland, no
chocolate from Belgium, no software industry in Israel or Ireland, and no video
games from Korea. All of these are fairly small countries. None possess unique
natural resources. In a modern economy, producers must plan from the beginning
to sell in a world market rather than to a domestic market.
Secondly, it is not just the absolute size of a market that counts, but alsohow
crowded it is. Domestic population per film produced, is shown in the following
table:
• US 454,000 • France 410,000 • Italy 460,000 • UK 1,050,000 • Germany 940,000 • India ,600,000 • Iceland 134,000 • Hong Kong 29,000 • Switzerland 196,000 • Ireland 303,000 • Israel 357,000 • Sweden 357,000 • EU average 667,000
44
In addition to the premium-budget Hollywood films, there are numerous
“indie” films made at a level of funding and technical expertise that in many
countries’ statistics are counted as full-fledged films. Independent film production
has seen significant growth. In 2010, 3,724 feature length pictures – a 43.2%
increase from 2005 – were submitted to the Sundance Film Festival in Park City,
Utah.2829
In concept, small or medium-sized countries can produce content for the rest
of the world. In music, there are many successful artists from medium-sized or
small countries in terms of population. For example, ABBA, the Swedish pop
group, the Beatles and the Rolling Stones, U.K, Bjork (Iceland, 1994), Diana Krall
(Canada), etc.
In books authors from small countries have often been global successes.
Examples are Agatha Christie (UK), Barbara Cartland (UK), Georges Simenon
(Belgium), Enid Blyton (UK), JK Rowling (UK), Astrid Lindgren (Sweden), Paul
Coelho (Brazil), Herman Hesse (Germany, Switzerland), and Gabriel Garcia
Marquez (Colombia).
28 David Carr, “New York ‘Little’ Films Grow Big,” The New York Times, Thursday, May 12, 2005 29 "2010 SUNDANCE FILM FESTIVAL ANNOUNCES FILMS IN COMPETITION."Sundance Festival 2010. 2 Dec. 2009. Web. 14 July 2010. <http://festival.sundance.org/2010/press_industry/releases/2010_sundance_film_festival_announces_films_in_competition/>.
45
But an exports-orientation also has an impact on content. If export revenues
rise in importance, content orientation in terms of themes and style becomes less
local and more global. International audiences may decode a work along the lines
of their own experiences, but they cannot be mystified by the work. Therefore,
content that aims at export is likely to shed some its domestic distinctions in favor
of a wider appeal. “Mid-Atlantic” or “mid-Pacific” content emerges, which appeals
across distances. In film, exports-oriented content chooses imageries that often
imitate Hollywood style. For example, in the late 1960s, some of the most
successful films out of Italy were the so called “Spaghetti Western”, which
emulated American cowboy films.
In much the same way, television content has also becomes export-oriented.
Endemol, a Netherland-based firm, develops TV formats for the world, such as
shows “Big Brother” and “Fear Factor”. There is very little content that is
distinctively “Dutch” or even just Western European. The same dynamics affect
American content. Not all content is equally exportable. Films with action,
adventure, physical comedy, and special effects generally travel well to other
countries. In contrast, comedy films are more difficult to translate in terms of
language and subtext. Race themes, too, do not export well.
46
A. Model: Small Country vs. Large Country
We can show this in a simple model. Let us assume two countries, the U.S.,
with a population of 300 million, and small country B, with a population of 30
million. Each country produces a film: each costing 1 million dollars to produce.
Each appeals to the same proportion (0.33%) of their domestic markets. If the
production budget declines, so do audience proportionately. Profit per ticket is $1.
Domestic audiences for the U.S. film spend $1 million on 1 million tickets, and for
country B domestically, $100,000 is made on 100,000 tickets.
Programs produced in one country – for its own audience – have diminished in
appeal in the second country due to cultural differences. This diminution is called a
cultural discount. We assume that there is a cultural discount of 40% for exports,
in both directions. Thus, whereas a film appeals domestically to 0.33% of the
population, for imports, that percentage is reduced by 40%, i.e., it is about 0.2%.
Taking into account the cultural discount of 40% we get, for the US film,
revenues of
$1, 000, 000 + $(1-0.4)*100,000 = $1,060,000
The offsetting production cost is $1, 000, 000, and the film is thus profitable.
Meanwhile, for the smaller country, domestic revenue = $1 * 100,000 = $100,000
47
And from the export to the U.S., taking into account the cultural discount,
(1-.0.4) * 1,000,000 = $600,000
The production cost is $1,000,000 so the net loss is
$1,000,000-$700,000 = $300,000
Thus, the film loses money.
What then are the options for a producer in the smaller country?
1st option: The film’s budget would have to be reduced, e.g. to $500,000.
This, however, will reduce the film’s attractiveness domestically and
internationally. It will also reduce audience size domestically, by half, to 50,000
domestically, and in the US to 300,000. The film will still be in deficit, by
$150,000 ($500,000- $350,000 =$150,000). True, costs have declined by half—but
so has the audience. So, reducing just the film’s budget does not help.
2nd option: Change the style of the film to better suit the home audience.
This option, which would change the style of the film to be more attractive
to its domestic audience, would raise the audience share of the film from .38% to
.5% for the film. But it will also reduce the attractiveness of the film to audiences
in other countries by raising the cultural discount by the same proportion. For
48
example, domestic audiences would rise to 150,000; the US audience, however,
would decline to 400,000. The film is still in deficit: $150,000 + $400,000 -
$1,000,000 = - $450,000
3rd Option: Make film less domestic
Now, the producer in country B produces content that highly appeals to the
larger market outside. This would reduce the cultural discount to 5%.
Reducing a cultural discount eventually means less of a national orientation.
This would make domestic audiences drop by 5% to 95,000, and US audience
would increase to (1-0.05)*1,000,000= 950,000. The film would finally become
profitable with revenues of
Domestic market = $1 * 95,000
US Market = $1* 950,000 = $950,000. So with a production cost of $1,000,000
Profit= $$95,000 + $950,000 – $1,000,000. = $45,000.
Conclusion on Market Size
A large domestic market helps content production. But it can be overcome if
a firm “thinks globally” not “locally” in its content strategy. This, however, means
a reduction of the national character of the content in order to appeal to a wider
49
audience. There will be, of course, instances in which the very “foreign-ness” of
content is its attraction. But, exceptions aside, that is more the case for critics than
for mass audiences.
#2 Political Power?
“Cultural Imperialism” is the projection of a strong country’s culture onto a
smaller and weaker country. Thus, ancient Rome or Babylon, or Britain and France
were able to protect their culture. But so were Greece and the small Italian city
states. America’s global influence has made its themes and values globally
familiar.30
Hollywood was dominant already before WWI and America’s ascent to
superpower status. And the American superpower status did not generate a smaller
dominance in books or theater. The Soviet Union, as a superpower, never had a
global content-shaping role. Thus, national power is one factor for content success,
but other explanatory factors are needed.
#3 VERTICAL INTEGRATION OF CONTENT WITH
DISTRIBUTION
30 http://www.kimetz.org/images/news/foucault.jpg
50
It is often argued that the success of the Hollywood producers is that they
control distribution channels which gives them advantages over competitors. Let’s
analyze this for a moment.
Producers are often vertically integrated. There are two kinds of vertical
integration. The first, backwards integration is when a company produces its own
inputs. By doing so, the company controls costs by controlling inputs. The other,
forward integration is when firms control distribution channels. This ensures
distribution, markets, and supply, while also helping to create product synergy.
What Do Film Distributors Do? First of all, film distributors promote and
advertise a film. They also deal with the physical aspects of distribution by
arranging for the delivery of the copies. This is their marketing function. They
might also exhibit the film in their own theater. They deliver the film to TV and
cable networks, and produce home video copies and deliver them to video stores.
They then collect rental fees, licensing charges, distribution payments, and other
payments, and disburse these payments to those parties entitled to them.
Lastly, they often finance the production of films by others in return for the
distribution rights and interest payments. The major distribution companies handle
products of their own affiliated production companies as well as those produced by
independent and foreign producers and even competitors. For these varied services,
51
they usually charge one third of all revenues collected from theaters and video
stores, after they first recover the expenses of advertising, printing and copying,
and other marketing expenses.31 More specifically:
1. Distributors get to keep an overhead charge, which is about 30% for
major distributors, 27.5% for smaller distributors, and up to 20% for
independent distributors and sales agents without national branch-
office networks, and for specialized films shown only in selected
locations.
2. The advertising billings for newspapers, TV, and other exposure are
paid for by the film’s incomes, plus an additional 10% overhead.
3. There is interest on the financing loaned by the distributor to the
producer for production costs.
The distributor’s compensation typically gets recovered first from box office
revenues before others get paid. 32
In the 1940s, the production and distribution, and even retailing, of films
were closely integrated. The Hollywood studios owned the most lucrative theaters
in the major cities. Paramount, for example, owned 1,236 theaters in 49 cities. Fox
31 Epstein, Edward Jay, “The Big Picture, The New Logic of Money and Power in Hollywood,” New York: E.J.E. Publications, Ltd., Inc., 2005
• 32Caves, Richard E. Creative Industries: Contracts Between Art and Commerce. Cambridge: Harvard University Press, 2000
52
owned 423 theaters in 177 cities. However, in the 1948 Paramount decision, the
U.S. Supreme Court outlawed vertical integration of distribution and exhibition
and the studios had to sell their theaters.33
What may be the business reasons for vertical integration?
• Vertical integration may be advantageous to content companies that
want to control the release of its products and their prices throughout a
“release sequence” of different outlets, different timings, and different
prices.
• A distributor could favor its own products and discriminate against the
products of others.
• Scarcity of attractive content, which provides market power to
distributors with superior access to them.
• Increased cross-marketing and cross-platform possibilities
• Extension of market power from one stage of the value chain to other,
e.g., from distribution to production.
Economists are generally skeptical about these alleged advantages of vertical
integration (with the exception of high market power in one stage being
extended into a competitive stage. An example of this would be Microsoft).
33 Noam, Eli. Mediacon, 2006.
53
In competitive markets, contracts can achieve all the advantages of vertical
integration such as: Vertical Integration makes economic sense mainly for a holder
of market power in a scarce factor. In the past, the scarcity was the distribution
power of the TV networks. Therefore, networks wanted to expand into production.
Then, distribution became more plentiful with cable and satellite TV and the scarce
element was now content. As a result, content producers have expanded to
distribution. More recently, distribution became more concentrated with broadband
internet, and internet providers show interest in a content role.
Control Over Distribution: The distributor can profit from price
discrimination by managing the amount and kind of promotion at each stage and
the elapsed time between them. 34
There are periods in which film theatrical releases are most frequent, in
particular during peak audience periods such as Christmas, Thanksgiving, and the
summer. But it could also make sense to release at holidays/uncrowned periods
where competition for attention is lower. Annual normalized weekly fluctuation in
U.S film attendance is shown in the figure below.
34 Caves, Richard E. Creative Industries: Contracts Between Art and Commerce. Cambridge: Harvard University Press, 2000
54
35
The following graph shows schematically a film’s release “windows” in a film’s
lifecycle.
36
35 Variety, copyright 1984 by A. D Murphy 36 Nasr, Andy. “Film Distribution Industry: Hooray for Hollywood!” Raymond James Equity Research - Canada. February 20, 2006. Pp. 10.
55
The basic principle for release sequence strategy is to first distribute to the
market that generates the highest marginal revenue over the least amount of time.
Then, cascade in the order of marginal-revenue contribution. This leads, typically,
to a sequencing of distribution, as depicted in the above graph. Similar graphs can
be developed for release sequenced for books and music.
The impact of piracy has affected the release timing. Video rental and
foreign releases come sooner now, which contracts film release windows. This has
practical implications on marketing campaigns where directors and stars visit each
major country as their film is about to be released, but this becomes harder when
all releases are in the same tight window.37
How does one analyze the optimal release sequencing? One model was
proposed by two marketing professors. 38 Knowledge of the sales parameters in the
first channel (theaters) helps to predict sales in the second channel (video rentals).
It also helps strategy in the second distribution channel. When does one release
film in the second channel?
37 Source: The Hollywood Reporter, October 10-16, 2000 38 Donald R. Lehmann and Charles B, Weinberg, Journal of Marketing, July 2000
56
Optimal time to open the second (video) channel.
In the above formula:
Optimal time to open the second (video) channel.
Decline of sales of the first (movie theater) channel
(30%).
Decline rate of the second (video) channel (6%).
n = Number of rental turns per copy for each time period, (example, three per
week).
p = Price to retailer per video (~$63).
r = Rental fee per copy (~$2.50).
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57
Gross margin in the first (theater) channel.
Gross margin in the second (video) channel.
Relative profitability of the two channels.
Relative size of the potential movie and video market.
The graph below represents the revenue distribution over time movie and video:
39
The optimal time to release a movie depends on the price to a retailer per
video, and a joint optimization problem involving both price and time.40 Results
determine the optimal time to release a home video, which depend on the “opening
39 Source: Donald R. Lehmann and Charles B, Weinberg, Journal of Marketing, July 2000. 40 Source: Donald R. Lehmann and Charles B, Weinberg, Journal of Marketing, July 2000.
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=VM
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58
strength” and the “decay rate” of a movie. Those parameters can be determined
early enough in a movie’s run to make the video release timing decision.41
In addition to the premium-budget Hollywood films, there are numerous
“indie” films made at a level of funding and technical expertise that in many
countries’ statistics are counted as full-fledged films. Independent film production
has seen significant growth. In 2010, 3,724 feature length pictures – a 43.2%
increase from 2005 – were submitted to the Sundance Film Festival in Park City,
Utah.4243
Favoring one’s own product can be sensible, but only if it is a stronger
product. It is not economically rational for a distributor to reject another producer’s
blockbuster and push its own less popular product into distribution.
Likewise, it is not economically rational for a distributor to be a captive
supplier and buyer for an inferior product of its own company. For example,
Disney, the TV show producer, should sell its new program to the highest bidder,
not to only to its network, ABC. ABC, in return, should buy the most attractive
programs, not specifically those from Disney’s.
41 Source: Donald R. Lehmann and Charles B, Weinberg, Journal of Marketing, July 2000. 42 David Carr, “New York ‘Little’ Films Grow Big,” The New York Times, Thursday, May 12, 2005 43 "2010 SUNDANCE FILM FESTIVAL ANNOUNCES FILMS IN COMPETITION."Sundance Festival 2010. 2 Dec. 2009. Web. 14 July 2010. <http://festival.sundance.org/2010/press_industry/releases/2010_sundance_film_festival_announces_films_in_competition/>.
59
The counter trends are disintegration and specialization.
Vertical Integration In Other Media Industries
In book publishing, vertical integration has been low. Book publishers do
not own distributors or retailers. In 2001, the Barnes & Noble retail chain tried to
buy Ingram, the largest book wholesaler/distributor. After significant opposition by
pulishers and other retailers, it dropped this plan. In 2003, B&N, still seeking
vertical integration, bought Sterling Publishing, a specialist in of out-of-copyright
classics, and became a publisher. Both Bertelsmann and Time Books have or had
big book clubs for distribution.
In television, vertical integration is high. Of the six major film producers, all
but one is vertically integrated into TV broadcasting stations, TV networks, or
cable networks. The one large Hollywood company missing from the list is Sony,
which is vertically extended into consumer electronics.
Vertical integration in cable TV: Now Moderate
The role of multiple system operators – MSOs –in content production used
to be greater. In 2008, Time Warner Cable’s (part of TW content production and
channels) was split off by TW.44
44 Fiveash, Kelly. "Time Warner and Time Warner Cable Split." The Register. 21 May 2008. Web. 15 July 2010.
60
Of the major cable companies, only Comcast (and the much smaller
Cablevision) have roles in content, and they are modest; however, the potential
acquisition by Comcast of NBC Universal would change that.
In music, production and wholesale distribution are fully integrated. This
was not always the case.
The role of the music groups in retailing was always modest, and the
exception—Virgin Music and its music stores—have declined.
G. Conclusions on Vertical Integration
Economists are generally skeptical about the advantages of vertical
integration. It works where market power lies in one segment and is expanded
to a competitive segment thus foreclosing markets to competitors. But the
source of the advantage is the market power, not the vertical integration.
Vertical integration is, furthermore, a double-edged sword. Its synergies have
been exaggerated by empire-builders and deal brokers, who often experience
major disappointments in the financial performance of the merged entities.
Access to Star Performers?
<http://www.theregister.co.uk/2008/05/21/time_warner_cable_spin_off/>.
61
Each commercial content industry has its stars. In the 19th century, for book,
Charles Dickens, Leo Tolstoy, and Emile Balzac had a hold over their national and
international audiences. In theater and opera, star performers such as Eleanora
Duse, Sarah Bernhardt and Enrico Cruso, staging the works of star playwrights,
such as G.B. Shaw and composers such as Guiseppe Verdi. The world’s first
movie star was Mary Pickford, 1915. Since then, stars have enlivened the film
industry. But are “stars” essential? Are they the secret of success in content
production?
A star may increase the tickets or copies sold. But the star also raises the
cost of a production considerably. This is a testable question. A study on 200 films
shows that stars play no role in the financial success of a film. Instead, there are
other variables associated with profitable films such as number of reviews, G and
PG ratings, and sequels of successful films.45
Films with the same star will often perform very differently. Leonardo
DiCaprio appeared in the films Titanic, The Man in the Iron Mask, and Celebrity,
in the same year. Titanic became the highest-ever grossing film of all time ($900
million in worldwide theatrical rentals). But The Man in the Iron Mask earned just
45 Epstein, Edward Jay, “The Big Picture, The New Logic of Money and Power in Hollywood,” New York: E.J.E. Publications, Ltd., Inc., 2005
62
$80 million, and Celebrity earned only $3 million. Thus, DiCaprio could not create
a huge audience by himself.46
Similarly, Julia Roberts – the highest-paid actress in 1997 – could not
consistently generate a large audience. Two romantic comedies with her as the lead
were released in 1997: My Best Friend’s Wedding earned $127.5 million, but
Everyone Says I Love You earned only $12 million.
Tom Hanks appeared in two consecutive movies, That Thing You Do!, $14
million, and Saving Private Ryan, $200 million. Eddie Murphy starred in The
Adventures of Pluto Nash and I Spy in 2002. I Spy did well, whereas The
Adventures of Pluto Nash was a financial disaster.47
There are advantages to stars, of course. They attract attention to the work,
help in promotion, reviews and free publicity. When a film star champions a
movie, his or her "bankability" may get it approved and produced.
46 Epstein, Edward Jay, “The Big Picture, The New Logic of Money and Power in Hollywood,” New York: E.J.E. Publications, Ltd., Inc., 2005 47 Epstein, Edward Jay, “The Big Picture, The New Logic of Money and Power in Hollywood,” New York: E.J.E. Publications, Ltd., Inc., 2005
63
But statistically speaking, in terms of profits, a star-filled movie raises the
producer's odds of suffering large losses and lowers its chances of making large
profits.48
The four traditional arguments for Hollywood’s success are its market size,
its political size, its use of vertical integration/production/distribution, and its stars.
All these few factors are relevant but not the essential or core reasons of success.
Instead of these conventional arguments, the major factor for Hollywood’s
economic superiority is the effectiveness of its production system. This may sound
surprising. Isn’t Hollywood the high-cost producer of content?
There are three types of factors for a superior production process:
A. Organizational structure
B. Risk Reduction
C. Product Development
These will now be discussed.
48 De Vany and Walls, “Does Hollywood Make Too Many R-Rated Movies? Risk, Stochastic Dominance, and the Illusion of Expectation” Journal of Business, July 2002, vol. 73, no. 3
64
III.1 ORGANIZATIONAL STRUCTURE
The old model
Up to the 1950s, the Hollywood film studios were mass producers (like auto
or steel-producers). They operated with a huge overhead cost. The huge and new
threat of television forced Hollywood to "re-engineer" itself earlier than other
industries. The main strategy of this re-engineering was to position themselves on
the high-end of the product spectrum and to lower overhead costs by shifting to
project-based style. Filmmaking moved away from being a mass-produced
commodity along the “flow-shop” model of production, to being a customized
production – a “job shop”-- based on ad-hoc specialists. 49
Contributors such as actors, writers, musicians, public-relations specialists,
cinematographers, editors, and financiers became free-lance specialists. Over
100,000 of the film industry's workers are freelancers, or work for companies with
less than 10 people.50
What the major Hollywood studios do is provide back-office support for
production teams, some financing, and distribution. This structure has several 49 Joel Kotkin and David Friedman, “Why Every Business Will Be Like Show Business,” Business Week, March 1, 1995 50 Joel Kotkin and David Friedman, “Why Every Business Will Be Like Show Business,” Business Week, March 1, 1995
65
benefits: a low-bureaucracy and overhead; and small pensions and health plans to
support.51
These trends restructure the industry from vertically integrated firms with in-
house talent and skills, to a system of horizontal specialists for hire. These traits –
flexibility, specialization, continuous learning, and intercompany cooperation –
also characterize the media and information industries at large and their production
activity. Computer companies in Silicon Valley are a good example of that.52
A networked structure for production emerges, shown in the following
illustration.
51 Joel Kotkin and David Friedman, “Why Every Business Will Be Like Show Business,” Business Week, March 1, 1995 52 Joel Kotkin and David Friedman, “Why Every Business Will Be Like Show Business,” Business Week, March 1, 1995
66
Similar network structures exist as emerge in other content media:
• Film production • Software development • Game development • Music labels • Book publishing • Many magazines
A. An example for specialization are technical skills
In 1977, computer processing was too expensive for long sequences, and
George Lucas wishes Star Wars could only afford to use computer graphics for one
ninety-second sequence. The sequence took several computers three months to
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complete.53 Lucas went on and started a computer-graphics company, Industrial
Light & Magic, which became a dominant visual-effects company followed by
companies, such as Lightstorm, Pixar, and Digital Domain also emerged as leaders
in developing computer graphic technologies. By 1999, computer technology
advanced to the point whereby the heads of stars could digitally place on their stunt
doubles. Russell Crowe’s face, in the movie Gladiator, was scanned into a
computer and then used on another’s body. Likewise, The Polar Express (2004)
used computer-generated characters to substitute for stars such as Tom Hanks.54
Projecting this trend, it’s only a matter of time before producers create
specifications with full ownership and copyrighted projections, just as they exist
for cartoon characters. 55
The greater power of computers and software lowers unit costs of rendering
computations but audience expectations have been rising, and there is therefore no
reduction in the actual investment in special effects likely.
53 Epstein, Edward Jay, “The Big Picture, The New Logic of Money and Power in Hollywood,” New York: E.J.E. Publications, Ltd., Inc., 2005 54 Epstein, Edward Jay, “The Big Picture, The New Logic of Money and Power in Hollywood,” New York: E.J.E. Publications, Ltd., Inc., 2005 55 http://www.spcgi.com/spboard/id/movie/screen_shot/simon.jpg
68
Specialists:
In 1977 the credits for the original Star Wars listed 143 technicians; the
sequel Attack of the Clones in 2003 listed 572 technicians in 2003.56
The team for “Toy Story” included seven PhDs in computer science, 22
technical directors, and 25 puppet, clay and stop-motion animators.
Clustering
Specialization encourages and feeds on geographic clustering. Clustering
creates opportunity of economies of scale. Hollywood is a geographically tightly
clustered industry with highly specialized suppliers in close proximity. Clustering
enables specialization, and permits economies of scale for specialized skills. It also
enables disaggregation of the production process into multiple firms and providers
that get assembled for each project into an ad hoc organization.
Clustering is prevalent in media and information sectors:
Other examples:
• “Madison Avenue” (advertising)
• “Sixth Avenue” (the 4 TV networks)
56 Epstein, Edward Jay, “The Big Picture, The New Logic of Money and Power in Hollywood,” New York: E.J.E. Publications, Ltd., Inc., 2005
69
• “Silicon Valley” (technology)
• “Bollywood”(film in Bombay (Mumbai), India), (techonology)
• “Publisher’s Row” (New York publishing)
• “Fleet Street” (UK newspapers)
• “Printer’s Row” (Chicago)
• “Soho” (art)
• “West End” and “Broadway” (Theater)
The three main reasons for the formation of economic clusters are:
1) Positive Externalities. The various specialists encourage each other. Their
presence attracts more specialists and business actively, a virtuous cycle.
2) Increasing returns to specialized factors. Specialists have learning and produce
more effectively as the aggregate of the work rises.
3) Competition and collaboration.57 In a cluster, competition can be fierce, but
cooperation is also needed by the members of the “community”.
Clusters encourage investment in reputation. This is because there are
repeated interactions among the parties in a cluster. As a result, reputations for
57 "Economics of Agglomeration." IDEAS: Economics and Finance Research. Department of Economics, 30 June 2010. Web. 07 July 2010. <http://ideas.repec.org/p/cpr/ceprdp/1344.html>.
70
high quality and cooperative behavior are predictors for future business support
quality and reliability.58
The Hollywood cluster is larger than film clusters in other countries, and
creates opportunities for greater specialization and greater investment in skills.
Companies outside Hollywood therefore have more trouble remaining on the
cutting edge of business practices and technical virtuosity.59
Specialization and decentralization of skill requires coordinators of these
specialized skills. In Hollywood, the key coordinators are distributors (studio),
independent producers, and talent agents.
(2) Independent Producers
It is difficult to define the role of a producer because of the profusion of
titles. “A producer can be anyone who calls him or herself such.”60 Theatrical
production created the model for independent producers, (which was expanded to
film.) In film, producers were originally employees of a large production company.
But in the late ‘30s, ambitious employee-producers left the major studios to operate
on their own. David Selznick left MGM in 1935. Gone With the Wind was 58 Caves, Richard E. Creative Industries: Contracts Between Art and Commerce. Cambridge: Harvard University Press, 2000 59 Joel Kotkin and David Friedman, “Why Every Business Will Be Like Show Business,” Business Week, March 1, 1995 60 Lindheim, Robert, “What is a Producer?”, Inside Television Producing
71
produced by Selznick as an independent production and distributed by MGM for
half the profits. MGM contributed Clark Gable as a star. Since then, Hollywood
has been giving independent entrepreneurs (“producers”) a stronger role than in
most countries, where they are usually salaried employees of media firms or public
TV institutions.
The executive producer is the prestige position. They have typically a
financial stake in the project and for the hiring of key positions, and often
guarantee for payment of salaries and expenses. The EP makes the business,
financial, and management decisions from script selection to funding to budget
controls. The supervising producer is the project workhorse. After that comes the
producer, who deals with the technical production aspects. Below, there is the
associate producer, who manages specialty tasks such as sound and films insert
shots. However, associate producers can also be the junior partners in a co-
production, and then carry much clout. The assistant producer deals with lower-
level details of administration and troubleshooting.
So this is the Structure of Hollywood:
• Entrepreneurial specialization in production
• Oligopolistic distribution
72
There are also similar structures – though less developed – for music labels,
book imprints, and video games.
III.2 REDUCTION OF RISK:
The second major economic factor in content production is risk reduction.
This is often mis-described as “access to capital,” and Hollywood, especially, is
said to posses, such access. But “access” is a meaningful concept only in
association with a price. In theory, most businesses have access to money, the
question is whether it’s at an affordable price and other conditions. The price of
money is the interest rate (explicit or implicit). And it is determined by the
perceived risk to the investor that must be compensated. This risk can be reduced
by managerial actions. Thus the relative access to capital is really a matter of
relative risk reduction.
We will now discuss risk reduction as a factor for superior production.
Media industries such as music, film, or even books face high failure rates,
around 80%. There have been cases where a flopped film entirely ruined a movie
studio such as (United Artists) – through Heaven’s Gate -- and (Carolco) through
Cutthroat Island – and nearly 20th Century Fox, through Cleopatra. A sample study
of 948 Broadway shows between 1972 and 1983 finds an aggregate loss of $66.6
73
million on a total investment of $267.5 million. The flop rate for musical comedies
was 76%, and for stage plays 80%.61 Successful producers have flop rates that are
lower but not low. David Merrick had a 61% flop rate for his plays between 1954
and 1968. Oscar Hammerstein had a 65% flop rate before Showboat, then 53%
before Oklahoma! 62
These probabilities have become still lower from 1998 to 2003. The
probability of reaching to top of a week’s audience rankings (for movies), or to
platinum status (for music) or the bestseller’s list (for books) declined by half. Of
new US primetime TV series, only a quarter survive beyond the first season,
whereas in the 1980s, it was a third63
At the same time, content production became more expensive. In Germany,
licensing costs in book publishing grew 9% CAGR from 1995-1999. TV sports
rights grew from 9%-14% in the 1990s at CAGR.
There are various techniques to reduce risk.
• Selection of lower risk projects
61 Caves, Richard E. Creative Industries: Contracts Between Art and Commerce. Cambridge: Harvard University Press, 2000 62 Caves, Richard E. Creative Industries: Contracts Between Art and Commerce. Cambridge: Harvard University Press, 2000 63 Aris, Annet, “Value-Creating Management of Media Companies: Chapter 5”, McKinsey & Company, Inc., 2003
74
• Insurance
• Lowering of exposure
• Shift of risk to others
• Diversification
• Hedging
B. Risk Reduction Strategy: Selection of Lower-Risk
Projects
Selecting lower risk projects such as prequels, sequels, or franchises reduces
risk because it is easier for movie producers to predict success or failure. Books by
a best-selling author, films starring a famous actor, imitations/sequels, or branded
products have already proved to be successful and are therefore less risky.64 It is
easier to market something people are familiar with and have responded positively
in the past. On the other hand, the possessors of these “homerun” inputs are well
aware of their value and will require major compensation, thus easily pushing the
project back into risky territory.
That so, sequels often tend to have a good run. James Bond movies (21 films)
had a worldwide box office of $3.4 billion dollars. Star Wars (4 films) was 64 Hirsch, Paul M. “Cultural Industries Revisited,” Organizational Science, Vol. 11, No. 3, (May-June 2000), 357.
75
followed by $2.7 billion dollars, while Indiana Jones (3 films) had $1.2 billion
dollars in worldwide box office receipts. However, sequels generally have higher
costs of production. The stars, after seeing the success of the first film, demand
more money in return. As a result, this can sink successful TV shows overtime.
Harry Potter books sold copies. George Simenon and Agatha Christie wrote
dozens of books and sold tens of millions of copies.
Forecasting is the science of predicting the future and its events. One may
use historical data followed by a mathematical model, or engage in subjective or
intuitive prediction, or both. The main objective of forecasting is to reduce risk in
decision-making; it is a starting point for planning. Forecasts are needed in many
different aspects of business, and top management require it for planning, and
implementing, long-term strategic objectives, as well as planning for capital
expenditures. Specifically, forecasts are needed to:
• Schedule production activities
• Order materials
• Establish inventory levels
• Plan shipments
• Purchase and procure materials and equipment
76
• Schedule labor65
There are a few different types of forecasting, including:
• Economic forecasts, which address the business cycle by predicting
inflation rates, money supplies, housing starts, and other planning
indicators.
• Technological forecasts, which are concerned with rates of technological
progress. This includes modern electronics, such as Apple’s iPod, and
hopeful technological advances, like bio fuels.66
• Demand forecasts, which are projections of demand for a company’s
products or services. This is also known as “sales forecasts.”67 Demand
forecasting may be used in pricing, understanding future capacity
requirements, or making decisions on whether to enter a market.68 An
example of demand forecasting would be Microsoft’s 2000 decision to enter
the video game industry with the X-Box. Based on a visible demand for
65 Ph.D., Jae K. Shim, and Joel G. Siegel Ph.D.. "Forecasting." Operations Management (Barron's Business Review Series). Hauppauge NY: Barron's Educational Series, 1999. 66. Print. 66 "List of Emerging Technologies." Wikipedia, The Free Encyclopedia. Wikimedia Foundation, Inc. 19 June 2010. Web. 22 June 2010. 67 Heizer, Jay, and Barry Render. "Forecasting." Operation Management. 5 ed. New Jersey: Prentice-Hall, 1999. 145. Print. 68 "Demand Forecasting." Wikipedia, The Free Encyclopedia. Wikimedia Foundation, Inc. 26 March 2010. Web. 22 June 2010.
77
video games, which had sales of nearly $7 billion in 1999, Microsoft
acknowledged the demand and created a competing product.69
The following chart displays the relationship between demand forecasting and
operation/production systems:
70 There are, basically, two approaches to forecasting, which are:
Qualitative—forecasts that are based on judgment and opinion, such as expert
opinions, sales-force polling, the Delphi method (experts, generally three different
types of participants: decision makers [5-10 experts making actual forecast], staff
69 Thurrott, Paul. "Microsoft to Enter Gaming Industry with X-Box." Windows IT Pro - The Leading Independent Community for IT Pros. 15 Mar. 2000. Web. 22 June 2010. <http://www.windowsitpro.com/article/performance/microsoft-to-enter-gaming-industry-with-x-box.aspx>. 70 Ph.D., Jae K. Shim, and Joel G. Siegel Ph.D.. "Forecasting." Operations Management (Barron's Business Review Series). Hauppauge NY: Barron's Educational Series, 1999. 66. Print.
78
personnel [assistants to decision makers], and respondents [group of people in
varied locations with valued judgments]71) and consumer surveys. 72
Quantitative—forecasts based on mathematical models that depend on
historical data and/or variables, in order to predict demand.73 Examples include
moving averages and weighted moving averages; exponential smoothing and trend
effects; simple regression; multiple regression; and trend analysis and classical
decomposition. 74
In order to reduce risk, it is important to lock-in sequel costs by contract and
reduce dependency on a star. It is also crucial to establish sequel IP (intellectual
property) rights in advance.
For details, see the chapter on “Demand Analysis”
B. Risk Reduction: Insurance
Insuring helps producers absorb costs when things go wrong. Even in film,
small injuries by stars can become a big deal. In 2000, actress Nicole Kidman
71 Heizer, Jay, and Barry Render. "Forecasting." Operation Management. 5 ed. New Jersey: Prentice-Hall, 1999. 146. Print. 72 Ph.D., Jae K. Shim, and Joel G. Siegel Ph.D.. "Forecasting." Operations Management (Barron's Business Review Series). Hauppauge NY: Barron's Educational Series, 1999. 67. Print. 73 Heizer, Jay, and Barry Render. "Forecasting." Operation Management. 5 ed. New Jersey: Prentice-Hall, 1999. 145. Print. 74 Ph.D., Jae K. Shim, and Joel G. Siegel Ph.D.. "Forecasting." Operations Management (Barron's Business Review Series). Hauppauge NY: Barron's Educational Series, 1999. 67. Print.
79
injured her knee while shooting “Moulin Rouge.”75 Two claims were made for
delays, resulting in $3 million worth of insurance losses. The same injury caused
her to drop out of shooting “Panic Room” a year later and exposed insurers to a
claim of $54 million. Producers went with a different actress but still had a claim
$7 million for delays and expenses.
In films, typically, almost 1.5% of a film’s budget is spent on general insurance.
For movies with outside funding from banks or investors a “completion bond”
is mandatory to insure that investors do not lose everything76. “Completion bonds”
are similar to insurance. They are purchased from a guarantor and compensate
studios and investors if the production runs out of money. Even movies which do
not require completion bonds are insured by studios in the event of unforeseen
circumstances. This practice has been the norm since the 1920s. 77 Major bonding
companies are owned or backed by large insurance companies. The guaranty fee is,
typically 3-5% of the production budget.
75 Epstein, Edward J. “Nicole Kidman's Knee Or, how the insurance business runs Hollywood.” Slate. 23 May, 2005. Last accessed on 18 June, 2008 at http://www.slate.com/id/2119328/ 76 Epstein, Edward J. “Nicole Kidman's Knee Or, how the insurance business runs Hollywood.” Slate. 23 May, 2005. Last accessed on 18 June, 2008 at http://www.slate.com/id/2119328/ 77 Epstein, Edward J. “Nicole Kidman's Knee Or, how the insurance business runs Hollywood.” Slate. 23 May, 2005. Last accessed on 18 June, 2008 at http://www.slate.com/id/2119328/
80
While bonding companies rarely take over a film, in those cases where they do,
they can decide how the movie will be completed and delivered.78 For example, the
1998 Film “The Adventures of Baron Munchausen,” had originally been budgeted
by British director Terry Gilliam and German producer Thomas Schuehly for $23
million. When the film went over budget to $31 million, film financiers took over.
The film required an infusion of another $15 million. But its US box office total
was only $8 million. In another example, “Malcolm X,” the 1992 film, as taken
over at $33 million by the end of principal photography. It had been planned for
$28 million. 79
Such reinsurer provides, through the completion bond, an enhancement to the
producer to change its subordinated debt to investment-grade level.80 The
guarantor rarely steps in, his existence keeps a producer and director on their toes
to avoid losing control. The insurer can also require risk reduction during shooting.
In “The People vs. Larry Flint”, the insurer worried about actress Courtney Love’s
alcohol and drug problems, and required the constant presence of a chaperone.
Step-wise investment commitment is the option contract that is prevalent in film
78 Goodell, Gregory. Independent feature film production: A Complete Guide from Concept Through Distribution. New York, NY, 1982.
79 Source: Independent feature film production: A Complete Guide from Concept Through Distribution, Gregory Goodell 80 Caves, Richard E. Creative Industries: Contracts Between Art and Commerce. Cambridge: Harvard University Press, 2000
81
and theater. For example, a producer might acquire rights to a book under an
option contract for $10,000, and commission a screenplay from a writer for another
$40,000 to $100,000. The producer and distributor, at each step, can proceed under
pre-negotiated terms that give them an exit strategy in case they choose to get out
of the contract.
C. Risk Shifting
Risk shifting
Risk reduction is the key element for the reduction of capital cost;
diversification is a central element. Content producers will reduce their risk by
shifting it to others, in particular, to:
• Outside investors
• Talent & performers
• Suppliers
• Buyers
• Typical project failure rates would destroy other industries, but
Hollywood thrives, thanks to the strategies of diversifying and risk
shifting.
• Other content production, though exposed to lower overall potential loss
82
apply (or should apply) similar techniques.
• Push inventory requirements on to suppliers. The suppliers will benefit
from the strong orders from the producers. But they will take the risk of a
supply-chain disruption.
C. Content Portfolios and Diversification
Financial theory shows that a portfolio of investments, each with a certain
risk, can achieve a lower risk by being part of a portfolio. This is called
diversification.
The first aspect of diversification is simple averaging. Suppose there is a
slate of four movies A-D. Each has a different probability of success.
Assuming people plant to go and see a movie on a weekend. If they decide
against a film A the likelihood that they will see film B increases, and vice versa.
A and B are negatively correlated.
The expected value of any range of outcomes is the sum of the products of
the probability times the result.
Assume a movie costs $10 million(movie A in the table below) to make, and
may return $10, 5, 4, -1, or -2 million. Based on past experience, the probability of
83
it making $10 million in net revenues is 0.3. The other probabilities are 0.4, 0.2,
and 0.1, respectively.
The sum of the probabilities of all possible events for a film must equal
100%, because one of them will occur.
Now that we have determined the probability of all possible outcomes, we
multiply the probability of each outcome by the dollar value:
The expected value of the project is the sum of probabilities times payoffs.
Let’s assume portfolio of movies that include:
Movie Cost Probability & Return Expected Value A 10M 30% 10M; 40% 5 M; 20% 4 M; 10% -1M; 5.7 M B 50M 20% -70 M; 20% 60 M; 30% 40 M; 30% 10M; 41 M C 100M 35% 200 M; 15% 100 M; 20% 90 M, 30% -2M; 102.4 M D 200M 50% 300M; 25% 250M; 15% 190M; 10% 150M; 256 M
The Expected Value for Movie “B,” for example, is
(.2*70) + (.2*60) + (.3*40) + (.3*10) = 41
Together, the expected value for the portfolio is:
5.7 + 41 + 102.4 + 256 = 405.1
84
The expected return on a portfolio is a weighted average of the expected return on
the individual assets. (In the above example, $405.1 mil).
The Expected Returns on Investment are as follows:
Movie A -- (5.7-10) / 10 = -43%
Movie B -- (41-50) / 50 = -18%
Movie C -- (102.4-100)/100 =2.4%
Movie D -- (256-200)/200 = 28%
Overall Portfolio -- (405.1-360)/360 = 12.5%
Thus we can see that the expected return on the investment is a moderate returns of
each separate project, ranging from 28% to a negative -43%.
Beyond averaging there is a second dimension of risk reduction to
portfolios. It is based on the possibility that the separate items are not independent
of each other but are correlated.
The goal of diversification is to reduce the variance of the portfolio as a
whole. The incremental risk of an asset depends on whether its returns tend to
vary with or against the returns of the other assets held. If it varies against, then it
85
reduces the overall variability of a portfolio’s returns. As long as returns on assets
are negatively correlated, (when one does poorly, while the other does well) even
extremely volatile assets in a portfolio, will have a lower volatility.
Finance theorists have used the concept of “beta” to describe stock
portfolios. Beta describes the sensitivity of a stock portfolio to broad market
movements. The overall stock market (represented by an index such as the S&P
500 or FT-100) is assigned a beta of 1.0. By comparison, a portfolio which has a
beta of 0.5 will tend to participate in broad market moves—but only half as much
as the market overall. A portfolio with a beta of 2.0 will tend to benefit or suffer
from broad market moves twice as much as the overall market.81 The formula for
beta is:
is the “covariance” between the portfolio return and the market
return
. is the “variance” of the market’s return (volatility squared).
81 "Beta." RiskGlossary.com. Web. 09 July 2009. <http://www.riskglossary.com/link/beta.htm>.
2
),cov(
m
mp ZZσ
β =
),cov( mp ZZ
2mσ
86
Beta is generally calculated from historical price time series. For example,
60 trading days of stock prices might be used to estimate covariance and variance.
What is the portfolio’s expected value?
A variety of titles attracts a range of audiences and reduces a media firm’s
vulnerability to a flop.82
Variance for Individual Assets
Take N deviations from the average rate of return for Asset A and square
each of them:
(Average Return of A – Actual return of A) ² … Then, average the products. The
resulting number is the variance for the asset. The higher the number, the higher
the potential risk of the asset. 83
In order to find the standard deviation for movie A ( ), take the
square root of the variance. The closer is to zero, the closer the expected
outcome is to complete certainty.
82 Picard, Robert, “The Economics and Financing of Media Companies,” Fordham University Press, 2002. 83 Brealey, Richard A, and Myers, Stewart C. Principles of Corporate Finance. Mcgraw Hill-Irwin, New York 2002Brealey, Richard A, Myers, Stewart C, and Marcus, Alan J. Fundamentals of Corporate Finance, McGraw-Hill Irwin, New York 2004Eli M. Noam, Production
σ a
σ a
87
The goal of diversification is to reduce the variances of the portfolio as a
whole. In order to estimate the rate at which the two films co-vary, multiply the
deviation of film A by the deviation of film B in each of N scenarios and then
average the products:
Covariance (A, B) = ((Deviation A1 * Deviation B1) + (Deviation A2 * Deviation
B2)+…(Deviation AN * DeviationBN))/N
For the covariant coefficient , divide that covariance by the product of the
standard deviations of Asset A and of Asset B:
Covariant coefficients range between 1 to -1. A value of -1 indicate a perfect
negative correlation (i.e., it indicates the elimination of unique risk). A value of 0
means that the returns on the two assets vary independently. A value of 1 indicates
a perfect positive correlation (i.e., it is a poor portfolio match). If the returns on the
two assets in a portfolio vary in perfect lockstep, the standard deviation of the
portfolio would be the weighted average of the standard deviations of both assets:
If the covariance coefficient equals 1, let:
-Xa = the fraction of film A in the portfolio
abρ
)σ * ( Covariance ρ
baab σ=
88
-Xb = the fraction of film B
The standard deviation of Portfolio (A, B) = (Xa * ) + (Xb * )
The incremental risk of an asset depends on whether its returns tend to vary
with or against the returns of other assets held. If it varies against, then it reduces
the overall variability of a portfolio’s returns.84
Advantages of Product Variation
The expected value of a given movie may be high enough to justify its
production, but its risk may be high enough to deter producers who cannot afford
to lose or to diversify.
Variance
Take 4 deviations from the average rate of return and square each of them.
Then, average that. If it’s high, then the variance is high. Now, take the square
root and the result is the Standard Deviation. The closer the outcome gets to
certain, the closer the Standard Deviation is to zero. 85
84 Brealey, Richard A, and Myers, Stewart C. Principles of Corporate Finance. Mcgraw Hill-Irwin, New York 2002Brealey, Richard A, Myers, Stewart C, and Marcus, Alan J. Fundamentals of Corporate Finance, McGraw-Hill Irwin, New York 2004Bodie, Zvi, Kane, AleEli M. Noam, Production 85 Picard, Robert, “The Economics and Financing of Media Companies,” Fordham University Press, 2002.
σ bσ b
89
A content Project portfolio balances among:
• Age of existing projects (life-cycle)
• Project development stages (avoid bunching)
• Audiences (advertiser considerations)
• Projects (non-variance, risk factors)
• Cost (overall budget constraints)
Because of high movie failure rates, studios attempt to build up the capital to
absorb possible failures with “sure things.” Studios can “hedge” more expensive
and more risky projects with less expensive or less risky ones,86 such as by making
sequels.
A slate of films is a form of portfolio. In 2006-2007, Paramount Pictures
released a variety of movies with different budgets and target demographics.
86 Business Week Online. “Battle of the Blockbusters.” 18 May, 2007. Last accessed 4 May 2008 at http://www.businessweek.com/investor/content/may2007/pi20070518_884011.htm
90
Portfolio Diversification of Paramount Pictures (2006/2007 season)
Movie Genre Budget Gross Reception Rating
Babel Drama/Thriller $20 million
$34.3 million (US)
$101 million (International)
6 Oscar Nominations; one Oscar win
R
Jackass Number Two
Comedy/Documentary $11.5 million $72.7 million (US)
$11.8 million (International)
64% Top Critic Rating (Rotten Tomatoes)
R
Charlotte’s Web Fantasy/Comedy $85 million $82.9 million (US)
$62.3 million (International)
72% Top Critic Rating (Rotten Tomatoes)
G
Dreamgirls Musical $75 million $103 million (US)
$51.4 million (International)
6 Oscar Nominations; 2 Oscar wins
PG13
Hot Rod Comedy ~$25 million $13.9 million (US)
$389,069 (International
25% Top Critic Rating (Rotten Tomatoes)
PG13
Ask The Dust Romance ~$10 million
$1.7 million (International)
$743,847 (US) R
• Babel was a thriller which included Oscar Nominee Brad Pitt and Oscar
Winner Cate Blanchett. The feature was rated R.87
• Jackass Number 2 was the sequel to Jackass: the Movie, based on an MTV
87 "Babel (2006)." The Internet Movie Database (IMDb). Web. 07 July 2010. <http://www.imdb.com/title/tt0449467/>.
90
91
reality series. This was also rated R.88
• Charlotte’s Web was based on a popular children’s book and was a remake
of an earlier adaptation. It was rated G.89
• Dreamgirls was a musical based on a 80s Broadway show and featured an
almost exclusively African-American cast. It was rated PG13.90
• Hot Rod was an original comedy, which received very low ratings and did
not do very well in theaters. It was rated PG13.91
• Ask The Dust featured superstars Salma Hayek and Colin Farrell but also did
not do well with audiences. It was rated R.92
How can one optimize a film star/portfolio?
The studio system reduces risk by pooling many risky projects, making their
aggregate cash flow reasonably safe for the lenders.93
88 "Jackass Number Two (2006)." The Internet Movie Database (IMDb). Web. 07 July 2010. <http://www.imdb.com/title/tt0493430/>. 89 "Charlotte's Web (2006)." The Internet Movie Database (IMDb). Web. 07 July 2010. <http://www.imdb.com/title/tt0413895/>. 90 "Dreamgirls (2006)." The Internet Movie Database (IMDb). Web. 07 July 2010. <http://www.imdb.com/title/tt0443489/>. 91 "Hot Rod (2007)." The Internet Movie Database (IMDb). Web. 07 July 2010. <http://www.imdb.com/title/tt0787475/>. 92 "Ask the Dust (2006)." The Internet Movie Database (IMDb). N.p., n.d. Web. 07 July 2010. <http://www.imdb.com/title/tt0384814/>. 93 Source: Caves, Richard E. Creative Industries: Contracts Between Art and Commerce. Cambridge: Harvard University Press, 2000
92
One form of portfolio creation is the bundling of risky discrete products into
a continuous-flow product. Risk is lower for continuous flow productions such as
TV broadcast channels and magazines because demand is less volatile than for an
individual film or story. Advance subscriptions lower risk further
Diversification mixes a variety of investments within a portfolio. The
portfolio approach can be applied to content production in film, books, music
recordings, and magazine titles. The portfolio approach, by reducing risk, reduces
the cost of capital for diversified media companies and increases their access to
financing. This is one of the major factors in Hollywood’s success: high-risk
projects at medium risk financing cost. Of course, it also reduces the overall
upside: even a blockbuster film will be partly offset by several money-losing
projects.
One element of risk shifting to investors, actors, etc. is through the
sequencing of profit participation. Those who receive “first dollar” are less risky
than those who are paid last.
93
E. Hedging
III.3 Funding
As a result of this risk reduction, Hollywood has access to higher levels of
project funding at a typically lower cost. The following table shows the numbers
involved, in terms of budget.
Most Expensive Films, in 2007 dollars ($mil)
War and Peace (1968) $560 Cleopatra (1968) $560 Titanic (1997) $247 Waterworld (1995) $229 Terminator 3 (2003) $216 X-Men: The Last Stand (2006) $210 Spider-Man 2 (2004) $210 King Kong (2005) $207 Spider-Man Returns (2006) $204 Wild Wild West (1999) $203
But, do big production budgets create profits? Many big budget films flop
dismally. Several of the largest flops may be seen in the following tables:
Major Flops Production Cost in 2007 Dollars ($mil)
The 13th Warrior (1999) $190 Van Helsing (2004) $168 Alexander (2004) $161 Poseidon (2006) $160 The World is Not Enough (1999) $160
94
Stuart Little (1999) $157 Pearl Harbor (2001) $157
Looking at this in terms of the percentage in which domestic box office covered
the production budget
The following chart shows how Hollywood out-spends other countries’ film
industries per film
Around the World in 80 days 21% Alexander 22.10% Basic Instinct 2 7.20% Pluto Nash 4.40% Gigli 11.50% Heaven's Gate 3.40% Ishtar 35.90% Waterloo 5.60% Zabriskie Point 12.90%
95
Hollywood spends $ 55 million per film on average, for the “negative cost”.
European films cost on average $3million. The average French film has a budget
of $4.2 million.
The following table shows the top 10 most profitable movies, based on
absolute profit in worldwide gross.
IV. Product Development as a Key Factor
As we discussed above, risk reduction is one of three major factors for
superior financing of production. Product development is the second key factor,
and will be discussed in this segment.
The basic stages of content production of similar to those of production generally:
• Concept creation
• Selection
• Development
• Production planning
• Procurement of inputs
• Production
96
• Post-production improvements and quality control
• Preparation for distribution
IV.1 Concept Creation (Style)
The content producer’s business decision is to choose the “pitch” level for
its product, such as “high-brow,” “low-brow” or “middle-brow.” The graph shows
schematically the relation between audience size and content pitch. The graph
orders content quality along the horizontal axis, ranging from low content pitch
level to high content pitch level. Shakespeare may be on the right; mud-wrestling
on the left. Audiences are willing to watch programs in a general range of their
97
first preference, though at a declining rate. This is depicted by the triangle, which
shows the overall viewership for a program pitch Q.
Accordingly, the maximum area is reached at the peak of the distribution
curve. Popular culture content operates on a broad appeal, aimed at the middle
peak of distribution of tastes. The second and third content producers (Y and Z)
will position themselves relative to X so as to maximize their audience triangles --
not quite identical in pitch but close.
Content Quality Level
Aud
ienc
e
XY Z
Content Quality Level
Aud
ienc
e
XY Z
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As more content channels are added, the spread of commercial offerings
move (rightward) toward higher quality. But it also moves leftward toward the
lower-quality offerings. This is the same for films and magazines. For books,
audiences tend to be better educated, and the peak of the distribution may be more
to the right.
Media products typically either aim at a mass market or niche market. Mass
market media products will be near the center of the taste distribution. Niche
products will be more at the edges. However, the center is likely to be crowded
with other products, and niches may well be less can tested, and audiences may
therefore be just as high, while higher prices may be achievable. Mass audience
products are typically short-term oriented and marketing-driven.
Niche-driven content is often less well-known, but has a considerable
aggregate volume. Examples of niche-driven content are Christian contemporary
Program Content Quality
Aud
ienc
e
XY Z
C
99
music, magazines for bicycle enthusiasts, or a travel guide for Borneo. Niche-
driven content is constrained by a limited target audience but the niches add up. 94
Niche books with sales below 40,000 account for almost half of Amazon’s
revenues. As storage and distribution become cheaper, niche products become
more economically viable.
At the same time, the opportunities for mass-market popular audience media
products also increase as global distribution becomes easier and cheaper, as world
literacy rises and cultures open up.
The divergence of the “popular culture” approach from the “niche” approach is
one of the differences of Hollywood film vs. the more elite-oriented “arts” films. In
film, there are two major perspectives on style. Hollywood perspective can be
summed up as follows: “film is show business. No business, no show.” In some
other film centers, is greater reverence is given to the creator than to the audience.
This is exemplified by the famous French-Swiss director Jean-Luc Godard put it:
“Who is the enemy? The audience!”95 96
The economic problem with the “auteur” approach centered around the
creator/director is known as the “moral hazard” issue. Creators strive for
94 Aris, Annet, “Value-Creating Management of Media Companies: Chapter 5”, McKinsey & Company, Inc., 2003 95 The Spectator, May 31, 1997 96 http://birthday.wz.cz/godard.jpg
100
recognition by their peer group— critical success but with less consideration for
cost or for audience success. Alexis De Tocqueville, the French political thinker,
wrote in 1830, after visiting America: “In aristocracies a few great pictures
[paintings] are produced; in democratic countries a vast number of insignificant
ones.”97
It is a common misperception that intellectually more demanding media
products are harder to create. Actually, creating a success in either is similarly
difficult, the numerous failures in gaining critical or audience success at every
level attest. From a list of the films most successful with audiences in recent years
one can identify stylistic elements that seem to capture audience approval.
Elements of “popular culture” in film (as well as popular novels, where
applicable) include:
• Brisk pacing
• Sexual tension
• Episodes of action and violence
• Special Effects
• Intrigue
• Mood music
97 De Tocqueville, Alexis, “In What Spirit the Americans Cultivate the Arts.”
101
• A novel approach to an old fable
• Happy ending or “wow finish”98
The following tables list the top-grossing world-made films from all time. We can
see what seems to be working well.99
Billion-Dollar-Earning Movies, 1999-2004
Film US Rentals
Foreign Rentals
World Video & DVD
U.S. TV
Foreign TV
Other Rights
Total
Harry Potter 1 (2001) $259 $259 $436 $87 $86 $52 $1249
Spiderman $202 $209 $464 $80 $82 $60 $1097
The Two Towers $170 $298 $484 $84 $90 $84 $1210
The Fellowship of the… $157 $276 $396 $88 $90 $86 $1093
The Return of the King $183 $176 $500 $80 $80 $110 $1129
Harry Potter 2 $131 $304 $496 $90 $95 $88 $1204
Finding Nemo $170 $182 $500 $80 $80 $110 $1122
Pirates of the Caribbean $170 $182 $500 $85 $80 $112 $1122
Attack of the Clones $155 $172 $480 $85 $95 $100 $1087
98 The Magical-Market World of Disney Monthly Review, April 1, 2001 99 Epstein, Edward Jay, “The Big Picture, The New Logic of Money and Power in Hollywood,” New York: E.J.E. Publications, Ltd., Inc., 2005
102
The Phantom Menace $220 $240 $440 $90 $95 $100 $1185
100
As Edward Epstein observed, all of these successful movies101:
• are based on children’s stories, comic books, serials, cartoons or for Pirates of
the Caribbean, a theme-park ride.
• feature a child or adolescent protagonist.
• have a fairy-tale-like plot in which a weak or ineffectual youth is transformed
into a powerful and purposeful hero.
• contain only chaste relationships between the sexes.
• feature bizarre-looking and eccentric supporting characters that are
appropriate for toy and game licensing.
• depict conflict- in spectacular ways but are non-realistic, and bloodless for a
rating PG or PG-13.
• end happily, with the hero prevailing over powerful villains and supernatural
forces (most of which remain available for potential sequels).
100 Epstein, Edward Jay, “The Big Picture, The New Logic of Money and Power in Hollywood,” New York: E.J.E. Publications, Ltd., Inc., 2005 101 Epstein, Edward Jay, “The Big Picture, The New Logic of Money and Power in Hollywood,” New York: E.J.E. Publications, Ltd., Inc., 2005
103
• use animation to artificially create action sequences, supernatural
forces, and elaborate settings.
• cast actors who are not ranking stars—at least in the sense that they do not
command major revenue shares.
• are costly to make: production costs for them alone averaged $105 Million.
Examples of blockbusters in other media are Lady Gaga or the Rolling Stones
in recorded music, or Stephen King and Danielle Steel in books.
There is no inherent reason why other countries’ studios cannot produce
popular content with an export success that is similar to Hollywood’s. Most
European, Japanese, Indian, Korean, Australian, Egyptian, and etc, films are not
“art,” but aim at popular taste, too. In other words, they try to be commercially
successful, but succeed less in export. The Indian film industry, known as
“Bollywood,” too, aims squarely at popular taste, where (chaste) love conquers all.
Bollywood films rarely mention politics, poverty or the grim social realities of
India.102 It, too, is produced mostly for a regional audience in South Asia. Yet,
Bollywood has been moving towards globalization, paralleling the broader shifts in
102 Mehta, Suketu. “Welcome to Bollywood,” National Geographic. Feb 2005. Vol. 207 Iss. 2.
104
the Indian economy. Both Hollywood and Bollywood succeed with audiences
because their orientation is demand-driven and popular. For instance, “Rang de
Basanti,” a film about a young British Indian, hit $24 million at the box office and
$9 million from outside India.103
Media firms must determine right mix between “mass market” and “niche
content.” It means deciding on the optimal portfolio mix; as described earlier
Competition in the entertainment industry is driven by search for “comfortable
novelty”. The content must not repeat past audience experiences, but still be
familiar and accessible. For example, millions may want to watch a sports event
that is familiar to them in terms of the basic structure, but only few people would
watch the same event twice.
This type of novelty combines familiar elements and styles.104 Even leading
edge creators who will try to be very different follow many conventions, such as
length of play, language, genre, etc.
Based on audience and advertisers’ feedback and research, media companies
may design “test tube” content. Examples: the creation of bands with members
103 Pfanner, Eric. “India’s new cinema has a global script,” International Herald Tribune, May 22, 2006. 104 Lampel, Josh, and Lant, Theresa, and Shamsie, Jamal. “Cultural Industries: Learning from Evolving Organizational Practicess,” Organizational Science. 11.3: 263-269, June 2000.
105
attractive to various demographics; the selection of reality-show heros; the endings
of films; etc.
Films get tested through sneak previews to help make changes. In theater,
content and the performance production is being tested through public
performances in stages from:
• Informal workshops, sometimes by nonprofit organizations, to small non-
profit, to commercial theater, to maybe TV and film
• to off-off-Broadway
• to off-Broadway
• to commercial Broadway
• Maybe pilot episode (for series)
Large media companies have tried to encourage content innovation by
allowing “boutiques” to exist within larger organizations. Film distributors created
semi-independent production companies and artistic studios. The music industry
has also used this model of small creative entities within the large organization.
Small independent labels, which are better at spotting new artists emerge, are often
bought by the big firms.105 A similar model applies to the technology sector where
small innovative startups, if successful, are often bought out by the established 105 “California Considers Tax Breaks for Filming,” New York Times, August 18, 2005.
106
firms. Book publishers, too, create small sub-publishers (“imprints”) run but
especially valued editors.
C. PRODUCT SELECTION
Selection among content ideas is a key media industry activity
• Typical investment per content production is significant
• Film: $70 mil
• TV series/pilot: $8 mil
• Book: Best Seller Potential: $.5 mil
• Video Game:$10 mil
• CD: Hit Potential: $1mil
• Any project competes for access to funding and other scarce resources:
• Management attention
• Marketing and promotion priorities
• Production facilities
• Release timing
107
Media firms must establish well-organized content generation processes.
Incorporating individual creativity is important but establishing a process of
selection and development is just as important.106
The staffing of major studios is fairly thin. They employ between 150 and
250 senior executives, called the “suits”107
It is claimed that of 10,000 theatre scripts, 1 play is produced; of 5,000
proposals for TV shows, one is chosen. Of film scripts, one in 5,000; and of novel
manuscripts, one in 15,000. But one must be skeptical of these numbers because
they count a proposal of the same work sent to multiple media firms as several
submissions.
Fox receives 10,000 screenplays, treatments, books, and oral pitches yearly.
Of all, 70 to 100 projects can move into development directly. Among these, only
12 films are created.108
In film, proposals are received through two major channels:
• Studio executives, producers, or established writers create concepts (story
106 Aris, Annet, “Value-Creating Management of Media Companies: Chapter 5”, McKinsey & Company, Inc., 2003 107 Epstein, Edward Jay, “The Big Picture, The New Logic of Money and Power in Hollywood,” New York: E.J.E. Publications, Ltd., Inc., 2005 108 Caves, Richard E. Creative Industries: Contracts Between Art and Commerce. Cambridge: Harvard University Press, 2000
108
ideas) and make the “30-second pitch.”
• A producer’s agent presents a script or book to the studio. 109
• Scripts are also sent directly by the writers, but without the filtering role of
an established agent, their chances are mixed.
Factors for Selection: Film
• The story, of course.
• Books: a book’s sales history can indicate a film project’s market potential
• Talent: directors, producers, stars can indicate market potential
• Money: pre-existing financing deals may enhance a project’s value110
In book publishing, the president of the Doubleday publishing house says
that of 10,000 submissions he received “over the transom” each year, only 3-4
were accepted. It may be a bit exaggerated but it shows how slim the odds are.
Novels face even worse odds (one in 15,000).111
109 Levison, Louise. Filmmaking and Financing. p. 64. 110 Levison, Louise. Filmmaking and Financing. p. 47-9. 111 Caves, Richard E. Creative Industries: Contracts Between Art and Commerce. Cambridge: Harvard University Press, 2000
109
In book publishing, editors read submitted manuscripts and write internal
evaluations. The business considerations for a screening of manuscript for books
selection are:
• Will the book sell?
• Is the book well-written?
• Competitive offerings
• Fit with rest of list
• Will book enhance reputation of imprint?
For TV program selection, 600 series ideas are chosen each year in the U.S.
for further development at the networks’ expense. But only several dozen out of
them make it to the pilot stage. About 15 shows are picked for regular
programming by each network. There is a funding commitment for about 13
episodes with an option contract for additional episodes.
Music content is selected by A&R (Artists and Repertoire) managers.
Selection of new artists is usually by small or independent labels. Most selections
are based on either success of genre or previous hits.112 Furthermore, music
companies use independent producers or A&R executives to select compositions,
112 Caves, Richard E. Creative Industries: Contracts Between Art and Commerce. Cambridge: Harvard University Press, 2000
110
and previous works by artist as well as they attempt to promote new style or genre
for diversification, too.
Video-games are typically created by independent developers. Some are
based on successful films or books (tie-ins and sequels) as well as past industry
hits.113 Publishers select marketable games to develop. [EN: Expand a little]
How to Select Projects?
Project selection is done in every industry; it is not only special to content
industries. How is it normally done?
• Receiving or generative ideas
• Selecting
• Monitoring and modifying
• Feedback
There are several economic techniques to evaluate projects:
• Payback Period Technique
• Discounted Payback Period Technique
113 Nussenbaum, Evelyn. NEWS AND ANALYSIS; Video Game Makers Go Hollywood. Uh-Oh. The New York Times, August 22, 2004
111
• Net Present Value Technique (NPV)
• Return of Investment (ROI)
• Internal Rate of Return Technique (IRR)
Net Present Value (NPV) is the present value of all future cash flows to
appraise long-term projects. Ct is the net cash flow in year t, r is the discount value,
and t is the time of the cash flow.
NPV=
Consider a film in which the total production cost comes to $10,000,000.
The revenue share of the theaters is half of the box office receipts. Those revenues
decrease each year exponentially, by half from $5mil to $625k. We assume a
discount rate of 12%. The table shows revenues and their discounted value.
Year Cash Flow, discounted Present Value
t=0
-$10,000,000
t=1 $2.232.143
012.1000.000.10−
112.1000.500.2000.000.5 −
112
t=2
$996,492
t=3
$444,862
t=4
$198,599
Total Net Present value is . The NPV in this case
is negative. The film would not be profitable, due to the revenues that are low
relative to investment cost.
In contrast, Film B, is an expensive film, with a total production cost of
$100,000,000. The share of theaters is again half of revenues, which decreases
each year exponentially from $100 mil to $10 mil. The net present value of the
revenues would appear as follows:
Year Cash Flow, discounted Present Value
T=0
-$100.000.000
T=1
$89.285.714
212.1000.250.1000.500.2 −
312.1000.625000.250.1 −
412.100.3125000.625 −
6,127,904 $ -12.1
4
0
=∑=t
ttC
012.1000.000.100−
112.1000.000.100000.000.200 −
113
T=2
$39.859.694
T=3
$17.794.506
T=4
$8,897,253
The NPV then adds up to . In this scenario, the NPV
would come out positive, meaning the film would be profitable, after allowing for
the time value of money.
A media firm must create a selection process not just based on personal
judgments, but reflecting the perspectives of the company as a whole, and
organized in a structured and transparent way. Input may also include marketers
and market researchers – a sensitive subject to creators. The danger of a structured
process is that of stifling creativity.114 Peter Chernin, President of News Corp,
observed all the benefits of size -- leverage, synergy, or scope -- are fundamentally
the enemies of creativity.
There will inevitably be expensive wrong calls, followed by finger-
pointing.115 Universal Pictures, after spending more than three years developing the
114 Aris, Annet, “Value-Creating Management of Media Companies: Chapter 5”, McKinsey & Company, Inc., 2003 115 Epstein, Edward Jay, “The Big Picture, The New Logic of Money and Power in Hollywood,” New York: E.J.E.
212.1000.000.50000.000.100 −
312.1000.000.25000.000.50 −
312.1000.000.25000.000.50 −
56.472.686 $12.1
4
0
=∑=i
iiC
114
script of Shakespeare in Love, decided in the end not to green-light it. Disney’s
subsidiary Miramax then bought and produced it, and the film went on to win
seven Oscars, including for Best Picture. To avoid taking blame there may be a
built-in incentive to play it safe by accepting projects associated with well-known
producers, directors, and stars.116
Inevitably, several statistical tools for project selection were developed to
improve the odds for success. For film, one such model is “MOVIEMOD”
(mentioned previously), a decision support system for pre-market evaluation of
motion pictures, proposed by marketing professors Mhanbir S. Sawhney, Jehoshua
Eliashberg, Jedid-Jah Jonker, and Berend Wierenga in 1997. MOVIEMOD model
produces forecasts of box-office performance and offers diagnostic insights into
the drivers of box-office performance, including marketing strategies. Generally,
the models do not work well.117
Success factors for content selection are as follow:
• Identify market opportunities and needs (i.e., audience research)
• Attract and generate ideas for content
Publications, Ltd., Inc., 2005 116 Epstein, Edward Jay, “The Big Picture, The New Logic of Money and Power in Hollywood,” New York: E.J.E. Publications, Ltd., Inc., 2005 117 Erasmus Universiteit Rotterdam, December 1997
115
• A structured process for selection
• Create testing of concepts
• Create and use feedback
D. Development
“Development” is the process by which a story idea or editorial concept is
written, revised, and improved. It is also the “D” in “R&D” for technology
products. According to one estimate, in 2002 the six studios and their subsidiaries
had more than 2,500 ideas in some stage of development with producers. Most do
not get produced in the end. For example, 90% of projects under development by
Paramount were not green-lighted.118 Projects that fail to get green-lighted are
either put in “turnaround,” which gives the producers the right to sell them to
another studio, or are simply abandoned.119
A film’s starting point is the story. It can be script-writer’s own idea, a
successful book, the news, or an agent’s project as a vehicle for his star client. The
idea must then be developed into a full script.120 The scriptwriting process is
118 Epstein, Edward Jay, “The Big Picture, The New Logic of Money and Power in Hollywood,” New York: E.J.E. Publications, Ltd., Inc., 2005 119 Epstein, Edward Jay, “The Big Picture, The New Logic of Money and Power in Hollywood,” New York: E.J.E. Publications, Ltd., Inc., 2005 120 Mark Winoker and Bruce Holsinger, The Complete Idiot's Guide to Movies, Flicks and Film, Macmillan:
116
broken into steps, with a contractible output defined for each stage and an option
for the purchaser at each step to continue for another round.
The screenplay goes through a dozen drafts. Scripts often get re-written until
the last moment as late as during the shooting or in the editing process. Given this,
the original writer may have no say in the changes made to the original scripts.
(However, an exception applies for Broadway theaters; in fact, the Writers Guild
Basic Agreement ensures that the scripts on Broadway may not be changed
without the playwright's consent.121) At the high end, screenwriters can be paid $2-
3 millions, and script doctors may be paid to revise the final draft at $100,000 to
$200,000 per week in Hollywood. Especially valued screenwriters may get a
percentage of the gross profits.122 This is known as “storyboarding.” The director
and writer plan how to get from script to shooting script, and create flow chart of
shots.
IV.2 PRODUCTION PLANNING
Indiana, 2001Eli M. Noam, Production 121 Caves, Richard E. Creative Industries: Contracts Between Art and Commerce. Cambridge: Harvard University Press, 2000 122 http://en.wikipedia.org/wiki/Film_budgeting
117
A major operational challenge for content production is scheduling:
production timetables, release dates, sequencing, and etc. Budgeting needs to be
continuously adjusted. Software packages makes this easier and faster.
Each day of film or music production costs a lot of money. For example, the
film Terminator 3 incurred a daily operating cost of $300,000. It is therefore
important to organize the process the production of a film, for example by using
experienced specialists and dividing tasks.123 In the 1997 film Tomorrow Never
Dies, the main star Pierce Brosnan was playing James Bond in London, while a
stuntman double playing James Bond was being filmed at another English location,
a third unit “Bond” was parachuting out of a plane in a Florida shot and a fourth
team was shooting a swimming scene with a stunt double in London. A fifth unit
was shooting another Bond double in Bermuda piloting a speedboat.124 Planning of
these scenes and coordination of secondary characters demands a further
developed planning mechanism—especially because of uncertainty surrounding
completion times for each of these scenes.
123 Epstein, Edward Jay, “The Big Picture, The New Logic of Money and Power in Hollywood,” New York: E.J.E. Publications, Ltd., Inc., 2005 124 Epstein, Edward Jay, “The Big Picture, The New Logic of Money and Power in Hollywood,” New York: E.J.E. Publications, Ltd., Inc., 2005
118
A. Operational Challenges for Content Production
B. Operations Management
“Scientific management” was started in the 1900’s by Frederick Taylor. He
envisioned the firm as a well-oiled machine, with defined process rules, clear
hierarchy, and each component being replaceable.
Taylor was lionized in his time, but his examples and stories were later
revealed to be often fake or mischaracterized. One of his successors and disciples
was Gantt. The latter created, among other things, the so-called Gantt Chart.
Tools of Operations Management are:
• Budgeting
• Capacity Planning
• Scheduling
• Priority Assignment
• Inventory Control
119
Activity-Based Costing
There are methods in which to assist in understanding when a company or
product will turn a profit. Activity-based costing (ABC) is a method of accounting
in which costs are realistically estimated for products and services.125 ABC
attempts to proportion common costs to products based on the resources consumed
by the products or services. ABC also permits costs to be allocated at the unit,
batch, process, or plant/organization level. It defines both cost and activity drivers,
which accurately portray the consumption of resources. The cost drivers are
selected based on what causes an activity to increase or decrease. ABC requires
five steps:
125 http://www.bnet.com/2410-13240_23-66459.html
120
Inventory Control
In some industries, it is important to maintain a reliable and sufficient inventory
of inputs and outputs for future use, such as:
• Paper supply by printers
• Printed books to meet orders by retails and libraries
• Copies of DVDs in a retail store for buyers and renters
Inventory provides:
• Protection against unforeseen supply interruption
• Smooth production flows
• Meeting a higher demand than expected
• Improved delivery speed
• Flexibility126
Inventory, however, is expensive to maintain, since it ties up capital and
requires storage. In some circumstances, inventory holding costs may account for
126 Blackmon, Kate, Steve Brown, Paul Cousins, and Harvey Maylor. “MANAGING THROUGHPUT.” Operations Management: Policy, Practice and Performance Improvement. St. Louis: Butterworth-Heinemann, 2001. 214. Web.
121
as much as 60% to 80% of the total cost of a product or service. 127 On the other
hand, shortages also end up costing money in terms of lost current and future
business.128
Monitoring inventory costs may be done by one of two methods: fixed-order
quantitative system or economic order quantitative system. Fixed-order system is
a continuous system for inventory in which a specific amount is re-ordered
whenever the level of inventory drops below a certain point.129 Economic order
quantity (EOQ) is a fixed order quantity that is used to minimize total inventory
cost. The formula for EOQ is as follows:
EOQ = √2AB/C
A = Annual Demand
B = Variable Ordering Cost
C = Variable Holding Cost130
Consider this example. Assume a Korean game manufacturer is planning on
releasing a new video game, but wants to minimize its inventory costs by using an 127 Blackmon, Kate, Steve Brown, Paul Cousins, and Harvey Maylor. “MANAGING THROUGHPUT.” Operations Management: Policy, Practice and Performance Improvement. St. Louis: Butterworth-Heinemann, 2001. 215-216. Web. 128 Ph.D., Jae K. Shim, and Joel G. Siegel Ph.D.. "Inventory Management." Operations Management (Barron's Business Review Series). Hauppauge NY: Barron's Educational Series, 1999. 274. Print. 129 Blackmon, Kate, Steve Brown, Paul Cousins, and Harvey Maylor. “MANAGING THROUGHPUT.” Operations Management: Policy, Practice and Performance Improvement. St. Louis: Butterworth-Heinemann, 2001. 216-217. Web. 130 Ph.D., Jae K. Shim, and Joel G. Siegel Ph.D.. "Inventory Management." Operations Management (Barron's Business Review Series). Hauppauge NY: Barron's Educational Series, 1999. 274. Print.
122
economic order quantitative system. Annual demand is 24,000 units, $10 cost per
order, and $5 holding cost per unit per year.
Gantt Chart131
A somewhat more complex planning tool is the Critical Path Method
131 http://www.netmba.com/operations/project/gantt/
123
The CPM was developed in 1957 by the chemical company DuPont. It
accomplishes the following:
• provide a graphical view of the stages of the project
• predict the time required to complete the project
• show which activities are critical to maintaining the schedule and which are
not
• Identifies bottlenecks and slack activities
The steps in CPM project planning are:
• Specify individual steps
• Determine the sequence of steps
• Draw a network diagram
• Estimate time for each step
• Identify the critical path (longest path through the network)
• Update the CPM diagram during project
An example for CPH is to plan a Web Site Design Process
124
132 133
The first activity is “design web site” (#1) which, for the scope of this
specific project, takes 2 weeks. Once George has finished the task of “design web
site,” the tasks “write HTML” (#2), “contact service provider” (#3), and “create
artwork” (#4) can begin. Completion of these activities enables progression to “test
software” (#5), which, in turn, enables the final task of “upload HTML” (#6) to be
completed.
Critical path analysis can be employed to analyze factors leading to
potential delays in the creation of the website. Of the activities to be completed
immediately after “design web site.” #3 and #4 take a shorter time to complete (0
132 http://hspm.sph.sc.edu/COURSES/J716/CPM/aoa1.gif 133 http://www.rff.com/pert_html.png
125
weeks and 4 weeks respectively) than #2 (5 weeks). Hence, #3 (and George) has a
“slack” time of 5 weeks and #4 (and Linda) has slack time of 1 week. No other
activities have “slack” time—if they are delayed then the whole project will be
delayed.
Accordingly, the critical path in this project is #1 → #2 → #5 → #6. If
items #3 and #4 are completed within their slack time, and all items on the critical
path are not delayed, the estimated length of the project will be the time taken to
traverse the critical path. This time can be calculated to be the length of #1 (2
weeks) + #2 (5 weeks) + #5 (1 week) + #6 (0 week) = 8 weeks.
134
134 http://www.rff.com/pert_hardware.png
126
As with the previously described website design model, the above
diagram lays out the flow of activities in a specific “PC Card” project. Here the
nodes, designated by numbers, determine a point on the path and the arrows define
the task that is needed to reach the point. The times to complete the tasks are noted
under the arrows. The critical path is denoted by the [red] arrows. As with the
previous web design example, note that not until “all specs finalized” (#2) has been
completed, can “hardware design completed,” “manual layout completed,” and
other key nodes in the project begin. Applying CPM methodology, we note that the
path 2,3,5,6,7,11 can run parallel to 2,6,8,11 and 2,4,9,10,11.]
CPM is most effective for projects with low levels of uncertainty for
completion times. Strong areas of application include magazines, books, and
regularly scheduled TV series for which estimated completion times and actual
completion times strongly match. However, for projects exhibiting greater
uncertainty in completion times, CPM exhibits limitations.
The PERT Methodology135
135 http://www.netmba.com/images/operations/project/pert/pert.gif
127
`The CPM model can be extended to account for uncertainties through
utilization of the “Program Evaluation and Review Technique” (PERT), a
technique that allows for randomness in activity completion times. This
methodology was developed in the late 1950s, for large defense projects with
thousands of contractors and tasks, each of which has a certain distribution for the
completion of each activity. The expected time for each task is approximated by
the following weighted average:
Expected time = (Optimistic + 4 x Most likely + Pessimistic)/6
PERT is invaluable as it provides not only expected project completion time,
but also probability of completion before a specified date.
128
Other Operations Research Methodologies
Operations Research is the use of mathematical statistics and models used to
aid in decision making.136 A key operations research methodology is linear
programming—an optimization tool useful for well-defined production processes
with well-defined constraints
Examples include designing the production flow in a DVD factory or
determining the capacity of a telecommunications network.
A linear programming model takes the following form:137
• Define an “objective function” which will be either maximized or
minimized, depending on the task (e.g, minimize cost for a given production
level or maximize production for a given cost level)
• This objective function is subject to a number of constraints which can be
expressed as equations or inequalities. For example, a constraint may be the
number of machines or it may be the overall demand; or supplier inputs.
136 http://en.wikipedia.org/wiki/Operations_research 137 http://www.netmba.com/operations/lb/
129
Examples for equations defining constraints:
138
Linear programming makes certain simplifying assumptions about linearity,
proportionality, and additivity, so that multiplications of all variables will not
change the results.
Another key application of Operations Research is the area of queues, or
mathematical models driven by waiting times. Queues are found in many
operations:
1. Customers in a movie box office lane
2. Callers for a cell phone service representative
3. Installation orders for cable TV
4. Artists in a recording studio
5. Films on a sound stage
138 http://www.netmba.com/operations/lb/
130
One of queuing theory concepts is “under steady state conditions, the
average number of items in a queuing system equals the average rate at which
items arrive multiplied by the average time that an item spends in the system.” 139
This statement, referred to as Little’s Law, is expressed as L= λ W.140
Where:
L =average number of items in the queuing system,
W = average waiting time in the system for an item, and
λ =average number of items arriving per unit time, the law is
Conclusion on Production Efficiency
Production cost can be lowered by various planning techniques. There is a
management opportunity in cost reduction of content production. This aspect of
production planning tends to be underdeveloped in the “project-based” structure of
Hollywood. Generally, “flow-oriented” media with repetitious operations makes
best use of these planning techniques. Key examples include:
1. Newspapers and magazines (editorial)
139 Little, John D.C, Graves, Stephan C. “Little’s Law” Massachusetts Institute of Technology. Last accessed at http://web.mit.edu/sgraves/www/papers/Little%27s%20Law-Published.pdf 140 Little, John D.C, Graves, Stephan C. “Little’s Law” Massachusetts Institute of Technology. Last accessed at http://web.mit.edu/sgraves/www/papers/Little%27s%20Law-Published.pdf
131
2. Design and construction of telecom and cable infrastructure
3. Actual production of books, magazines, CD’s, DVD’s
4. Soap operas and TV series (“batch jobs”)
Performance and Quality Control
There are specific ways in which to measure the success of a business,
product, or organization. Traditionally, performance measurement’s focus has been
strongly financial, extending all the way back to the double-entry book keeping of
fourteenth century Venice. As businesses grew, so did measurement techniques.
Once a new media product opens, especially a continuous-flow type, the company
must continuously monitor the production for performance and quality assurance.
Performance metrics to watch are of each products:
• Audience size and trend
• Audience composition
• Market share
• Reduction cost
• Churn & loyalty
• P-factors of stars
• Fit with other content products
132
• Speed to prototype141
• New subscriptions
• Churn reduction
• Number of new titles launched
• Readership distribution
Performance Measurement
Productivity
“Productivity,” describes how efficiently an operation performs in
transforming inputs into outputs. Efficiency measurements differ from actual
product or service outputs with that of the standard output level of the product or
service. Productivity measures the units of product or service produced per inputs
such as employees, or per unit of time. A simple ratio exists for figuring out the
efficiency of a given product or service: !"#$%!"#$"#
. This is measured in labor, space,
and other such individual variables.
Hollywood produces more films than any other production center or country,
including India. Hollywood is, therefore, productive in an absolute sense. On the
141 Aris, Annet, “Value-Creating Management of Media Companies: Chapter 5”, McKinsey & Company, Inc., 2003
133
other hand, Hollywood productions are vastly more expensive than those of
Europe and Asia. Therefore, is its productivity lower?
Productivity, as discussed, can be defined as the ratio of outputs to inputs
expended. The following are common measures for productivity in the media:
1. Revenues/Employee
2. Value-Added/Employee
3. “Total Factor Productivity”
4. Value of output/cost of inputs
Econometric Estimation of Production Function Estimation
Similar (and more convenient) cost functions:
Q = Output
K: Capital Inputs
L: Labor Inputs
X: Other Factors
XLKBQ
XLKQ B
lnlnlnlnln
λγ
α
α λγ
++
+=
=
134
However measured, productivity can be compared across years, industries, and
countries.
Productivity in Film
Different methods of measuring productivity yield divergent insights—when
outputs are measured in physical units (i.e. film or TV shows), Hollywood
productivity is lower than that of India’s or Europe’s (in absolute numbers as per
US$ of investment).
Rank Release Date Movie Distributor Budget US Gross
(Mil $)
Worldwide Gross (Mil
$) 1 1993 El Mariachi Columbia $7,000 $2 Unknown 2 1991 Slacker Orion Classics $23,000 $1 Unknown 3 1995 Brothers McMullen, Fox Searchlight $25,000 $10 Unknown 4 1972 Deep Throat Damiano $25,000 $45 Unknown 5 1994 Clerks Miramax $27,000 $3 Unknown 6 1999 Blair Witch Project Artisan $35,000 $140 $248 7 2004 Osama United Artists $46,000 $1 $2 8 2001 Gabriela Power Point $50,000 $2 Unknown 9 2004 Super Size Me IDP/Sam Goldwyn $65,000 $11 $29
Rank Release Date Movie Distributor
Budget (millio
n)
Worldwide Gross (Mil $)
1 1997 Titanic 20th Century Fox $200 $1,835 2 2003 Lord of the Rings: The Return of the King New Line $94 $1,129 3 1993 Jurassic Park Universal $63 $920 4 2004 Shrek 2 DreamWorks SKG $70 $916 5 1977 Star Wars 20th Century Fox $11 $797 6 1982 ET: The Extra-Terrestrial Universal $10.5 $792 7 2002 Lord of the Rings: The Two Towers New Line $94 $924 8 2001 Harry Potter and the Sorcerer's Stone Warner Bros. $125 $974 9 1999 Star Wars: Phantom Menace 20th Century Fox $115 $925
135
142
The following table shows the top 10 most profitable movies based on return of
investment.
Rank Release Date Movie Budget Worldwide Gross (mil
$)
% Return
1 1999 The Blair Witch Project $35,000 $248 354614 % 2 2004 Tarnation $218 $662 151738% 3 2004 Super Size Me $65,000 $29 21854% 4 1973 American Graffiti $777,000 $140 8909% 5 1969 The Stewardesses $200,000 $25 6150% 6 1937 Snow White and the Seven Dwarfs $1,488,000 $185 6116% 7 2004 Napoleon Dynamite $400,000 $46 5607% 8 2004 Open Water $500,000 $52 5110% 9 1939 Gone with the Wind $3,900,000 $390 4906% 10 1915 The Birth of a Nation $110,000 $11 4900%
143
In general, studies have shown that big budgets do not contribute to
profitability. If anything, they may contribute to losses. The long time Paramount
head Sherry Lansing summarized her philosophy: “I’m not interested in box office
and I never have been. I’m interested in profitability.”144
142 "Movie Budget Records." The Numbers. N.p., 2009. Web. 5 July 2009. <: http://www.the-numbers.com/movies/records/budgets.html> 143 "Movie Budget Records." The Numbers. N.p., 2009. Web. 5 July 2009. <: http://www.the-numbers.com/movies/records/budgets.html> 144 Epstein, Edward Jay, “The Big Picture, The New Logic of Money and Power in Hollywood,” New York: E.J.E. Publications, Ltd., Inc., 2005
10 2002 Harry Potter and the Chamber of Secrets Warner Bros. $100 $878
136
A strong financial structure to invest significant capital into movies is
missing from other production centers, resulting from less commitment of risk
capital. Even in major countries, much of film funding is supported by government
through grants, tax benefits, and public TV sources. This leads to content that will
often be oriented to national culture rather than export success.
But, when output is measured by tickets sold, India is highest, while Europe is
very low.
1. Identify all activities that are performed within the operation
2. Categorize the activities as value-added or non-value-added
3. Select cost drivers
4. Allocate total budget to the activities
5. Identify the relationships between cost drivers and activity centers. 145
The below chart illustrates a two-stage system, which is the most common form
of cost allocation from an ABC system:
145 Blackmon, Kate, Steve Brown, Paul Cousins, and Harvey Maylor. "PERFORMANCE MEASUREMENT AND IMPROVEMENT." Operations Management: Policy, Practice and Performance Improvement. St. Louis: Butterworth-Heinemann, 2001. 313-314. Web.
137
146
People do not consume more content because it is cheaper to produce. To
the contrary, with people’s time and attention limited, they allocate it to attractive
productions that are expensive in terms of production and stars. They usually
prefer to watch a $100 million rather than a $10million film, because it is likely to
give them more visual attraction, scenes, and more famous stars. Of course, if
tickets for that film were to cost ten times as much, things would be different. But
that is not the case. Consumer prices are based on marginal cost (and high budget
films) and over the long run on average costs, which in the case of big budget films
may be spread over many more viewers.
One needs to go a step further. Big budgets raise revenues, and in the
process, lower average cost per ticket sold, but that does not necessarily mean that 146 Blackmon, Kate, Steve Brown, Paul Cousins, and Harvey Maylor. "PERFORMANCE MEASUREMENT AND IMPROVEMENT." Operations Management: Policy, Practice and Performance Improvement. St. Louis: Butterworth-Heinemann, 2001. 313. Web.
138
profits go up with higher production budgets. The impact of an increment in the
budget on returns decreases as a movie’s performance rises.147
The table below shows that a 1% in production budget is associated with an
increase of revenues of 0.636% in the case of the lowest-budget 10% of films. In
contrast, as for the highest budget 10% of films, such a 1% budget increase results
in only 0.44% of revenue increase.
Lowest decile 0.636
Median 0.56
Upper quartile 0.52
Top decile 0.44
Of course, some low-budget films do very well. The following table lists
extremely low budget films that earned $1 mil or more at the U.S. box office.
Top 10 Movies with Lowest Budgets to Earn $1 Million at US Box Office
In most other production activities, the high-cost producers will fail, but
apparently not in film.
147 DeVany, Arthur. “Laws of Production and Cost,” The Movies, April 19, 2005, 53.
139
However, the Hollywood big budget is spread over a much larger audience,
and its production budget per viewer is hence smaller than for a European film.
Film Budget per tickets sold (in $):
Hollywood $1.65 Bollywood $0.43 Europe $12.50
Thus, for each ticket that is sold, Hollywood spends less than its European
counterparts. Its budget may be much higher, but so may be the number of tickets
it generates per film.
And when output is defined using revenues, Hollywood becomes more
productive than India and much more productive than Europe.
Investment/Film (US$ M.)
Worlwide Tickets/Film (US$ M.)
Worldwide Tickets/ Investment (US$ M.)
Overall Rev/Investment
US 70 17 0.25 1.27
Europe 7.5 0.6 0.08 0.40
India 1.5 3.5 2.31 1.19
140
The Learning Curve
A European film company may produce 5 films a year, and is likely to be a
young firm. European firms are, on average, c.25 years old and have an average
track record of c.125 films. Alternatively, Hollywood distributors have an average
age of c.90 years and produce on average c.30 films per year.. Some have worked
on 4,000+ films, as well as on B-movies and TV serials.
The Hollywood product, while greatly more expensive, generates larger
revenue per budget dollar.
Productivity in Software Development
Key metrics for measuring productivity in software development include:
1. Number of software products completed
2. Number of features delivered in products
3. Size of the products such as lines of code (LoC) or function points
(FP’s)148
From 1990 to 1995, productivity in the software industry decreased 10% in terms
of products completed, or revenues generated. This was the worst decline of all
148 Source: Zells, L., “Managing software projects : selecting and using pc-based project management systems”, Wellesley, Mass. : QED Information Sciences, c1990.
141
industries surveyed. Factors contributing to this were dropping prices and a greater
complexity of products.149
Productivity of Journalists
The easiest method of measurement involves tracking production output, or
work completed by journalists. This could be defined as articles written, articles
edited, photographs made, pages laid out, etc.150 However, this lacks dimension of
quality. Other ways to measure journalistic productivity therefore include
measuring input activities done by journalists, such as phone calls and interviews.
Balanced Scorecard
In order to help keep track of a business’s performance, many businesses
utilize the balanced scorecard. Developed by accountants Robert Kaplan and David
Norton in 1996, the “balanced scorecard” is a representation of an organization’s
good performance in regards to stakeholder groups. The following image displays
a typical balanced scorecard. 151
149 Anselmo, Donald, and Ledgard, Henry. “Measuring Productivity in the Software Industry.” Communications of the ACM. 46(11), 121-125. 150 Picard, Robert G. “Measuring and interpreting productivity of journalists.” Newspaper Research Journal. 19(4): Fall 1998. 151 Blackmon, Kate, Steve Brown, Paul Cousins, and Harvey Maylor. "PERFORMANCE MEASUREMENT AND IMPROVEMENT." Operations Management: Policy, Practice and Performance Improvement. St. Louis:
142
152
Interactive content is also created and distributed under a second model—the
community model. In the community model, modules of media creation and play
modules will be created by decentralized peers, collaborating loosely with each
other.
In the development of interactive content, the major firms are mainly
coordinators and integrators of the specialist firms, as well as branders of the final
products. This structure is the organizational model for media production in the
future.
Rising Production Costs for New Media
Butterworth-Heinemann, 2001. 313. Web. 152 Blackmon, Kate, Steve Brown, Paul Cousins, and Harvey Maylor. "PERFORMANCE MEASUREMENT AND IMPROVEMENT." Operations Management: Policy, Practice and Performance Improvement. St. Louis: Butterworth-Heinemann, 2001. 314. Web.
143
Although the cost of production hardware has declined greater, thus enabling
the entry of small independent producers, it would be a mistake to believe that
these are overall production costs have declined. From 1990-1999, Hollywoods
average “negative costs” doubled from $26.8 million to $51.5 million.
This rise in production cost will be even greater with next-generation content
based on broadband and ultra-broadband connectivity throughput. These elements
will create such entertainment experiences with user immersion, user participation
and some user control.
Globalization
The lower costs apply to everybody, and as a result much more content is
being produced and supplied. As content supply rises relative to the fairly steady
stock of attention, the general expectations on production quality standards rise,
and with them the cost of production. There will be an even greater pressure for
“blockbuster” content that stands out from the crowd, and for content that makes
the most of the multi-media and interactive features of broadband and ultra-
broadband communications. Internet TV’s use is for applications that go beyond
regular linear TV: interactive, asynchronous, linked multimedia.
To produce such content is expensive. It requires creativity, programmers,
performance testing, and continually new versions. Such content exhibits strong
144
economies of scale on the content production side, and strong network effects on
the demand side.
1. Big budgets
2. Diversified risks
3. Access to distribution over multiple platforms
4. Brand recognition
5. Content aimed at large audiences
6. Ability to coordinate specialized inputs
7. Ability to creat product tie-ins
8. Ability to establish global uses communities
At the same time, the broadband internet means that programs can be
distributed globally at a relatively low cost. It’s been termed the death of distance.
People in Peru, Panama, and Portugal can select, click, and download. The
protection of distance is thus giving way, as are the protections of regulation and
licensing.
The content itself exhibits strong economies of scale. Once produced, it can
be reproduced at almost no cost. And it can be distributed, with the internet, quite
cheaply, and without much sensitivity to distance. This means that the content of
Hollywood, adapted for interactivity, can be all over the world. Of course, there
will also be opportunities for other producers to create and distribute specialized
145
programs for niche and general audiences. And those could be met by providers
from other countries.
In creating such new types of content, new ideas on content, format, and
interactivity will come from new directions and new firms. New types of content
production specialists will emerge on the technology side, often in Silicon Valley,
a cluster of innovation. For games, there might be sub-clusters in Japan and Korea.
But the networked structure of the established Hollywood media companies
will absorb these innovators seamlessly. It is precisely this structure that can cope
with change and innovation brought about by others.
In fact, this network structure is strengthened by more powerful
communications pipes, since the clustering can spread beyond those of geography.
Thus, “Hollywood” will become less of a description of geography, and more of an
industry structure.
It is likely that such integrators will also emerge in other production centers,
such as India, Europe, or Japan. Some firms will certainly emerge there, based on
those regions’ cultural, technological, and financial resources.
They will require some of these elements:
146
The major audiences will still be attached to big-budget, technically
sophisticated productions that combine glitz with technology. In this environment,
Hollywood will be even stronger, because it now has a more direct link to global
audiences. It does not have to go through the intermediaries of TV networks, and
pass through the regulation of governments.
It has the ability to fine-tune prices. And it can deploy in its network of
specialists also the talent and creativity from everywhere—animators from Japan;
special effects software in India; post-production in Shanghai; venture finance in
London; advertising companies in New York.
A century of film content production history should teach us some lessons.
Artistic creativity is not enough. The transition to packetized and internet-worked
communications will not reverse an industry structure built on underlying
economics that favor a particular production cluster.
The only way for other countries’ film industries to become a bigger factor
for the attention of global audiences is for them to resort to managerial responses
and to stop finding comfort in cultural criticism and political protectionism.
Conclusions: What Works for Content Production?
147
We explained the elements of competitive advantage in content production:
consistently produced products with a wide-appeal at a high cost, but a relatively
low average cost per user.
What does it take for success in content creation and production? Creativity
and originality, of course. But that is not enough. Content creation requires
“organized creativity.” The image of content creation is individualistic. In reality,
however, it is a collaborative effort, in the same way that individual inventors have
largely been superseded for major innovation by organized R&D efforts by
development teams of large or specialized firms.
In the media and communication sector, content creation is an increasingly
organized team effort. Newspapers, for example, rely on reporter teams, editors, a
newsroom etc. Performance arts, such as theater, dance, and music, depend on
troupes, orchestras, and bands. Software and game companies rely on large
development teams. In fiction novels, the author (still largely the solitary creator)
works with editors and marketers. But other books, educational, reference, and
“how-to” books rely on author teams, editors, and marketers.
Content creation is a high risk maneuver, trying to meet the voracious but
unpredictable audience demand for entertainment and information. There is an
intense competition for audience attention. Film may be the forerunner and path
148
breaker for most types of content creation, specifically “Industrialized craft project
production.” And within film, the advanced production model is in Hollywood.
So what do we deduce to be the elements of success for commercial content
production? People can imagine dark conspiracies that keep Hollywood successful.
They should instead look at Hollywood as a new business model. Most of its
elements are artistic only secondarily, but managerially first.
The conventional wisdom is that control over distribution is the key, but
distributing and sequencing can also be controlled by contract, and does not require
the vertical integration of production with distribution. Distribution is indeed
important, but ultimately it is the appeal of the content product ideas that counts.
Similarly, the domestic market size is less of a constraint if content is produced
with an export orientation.
Key success factors for media production are diverse and can be grouped by focus:
Risk-Reduction Techniques—Success Factors
Enable expensive production under uncertainty and risk through
• System of risk financing;
• Portfolio diversification;
• Sharing and risk-shifting, with a smaller share of risk than of reward;
149
• Transformation of discrete projects into a flow model.
Product Development—Success Factors
Key success factors in product development include
• Market Orientation;
• Popular-taste oriented style and niches;
• A strong pipeline of project proposals;
• Budget and Cost tracking.
•
Organizational Structures—Success Factors
The real and important success factor of business efficiency, however, is that
Hollywood has developed a new business model. That business model is
important to all industries and all companies, not just in the media sector.
• Project-based, ad-hoc organizations with low fixed costs, high project
entrepreneurship
• Highly-skilled labor pool
• Skewed reward system as incentive to creators
• Competitive creation, oligopolistic distribution
• There is competitive creation and oligopolistic distribution.
150
By analyzing Hollywood, we may find the beginning of a new content production
system.
Content Production is a “Network Industry”
The elements of content production re-enforce each other. There is
geographic clustering, as well as constant artistic and business interchange, as well
as interaction and information exchange. There is also a physical agglomeration of
activities, which creates proximity to skills and re-structuring (disintegration) of
content production. We can also see these developments now moving to the
breakup of electronics and other companies, with some specialist firms doing the
design, others making the components, others manufacturing, and others doing the
marketing. Hollywood has developed this model not because of its superior access
to management gurus, but because it has been engaged in a Darwinian process.
151
Each year about two hundred major films are being produced. Each of the
major films cost about 70-100 million to make, and 40 million or more to
promote. Many of these films disappear within days. Thus, under the pressures to
sink or swim, companies and business practices evolve and reengineer themselves
continuously.
People still talk about the “studios,” and believe that a few highly
concentrated conglomerates are producing all these movies. This is not so. The
Big Six are mostly in the business of distributing films made by small independent
or semi-independent firms. The studios also finance some of them, fully or partly.
They may rent them production facilities, but their share in the actual production
152
of the major films they distribute keeps declining, and is probably less than 20%
now. (There are many gray shades between outright studio production and truly
independent production.)
The studio companies (and similar companies in other sectors of media) are the
integrators of this system, but they themselves are small relative to their activity
level: low-bureaucracy, low overhead, low risk assumption, and low benefits to
support. Most expense is not for overhead, nor is most activity project based; most
human resources are freelancers.
Thus, Hollywood today is hundreds of small independent production
companies, which in turn use hundreds of specialized firms with special skills. All
use mostly free-lancers (i.e., independent contract labor rather than regular staff).
Even management staff is project-based.
This has restructured the industry from one of vertically integrated firms with
in-house skills – which is the traditional image of the Hollywood firms – to one of
horizontal specialists for hire. This forces studios to concentrate on the
coordination of multiple skills and elements, with an emphasis on multi-national,
multi-cultural, and multi-media orientation.
The model of the project-oriented, almost “virtual” production firm can be the
forerunner model for many business operations in general.
153
• Decentralized
• Networked
• Virtual
• Freelance
• Global
It is an organizational model that integrates creativity with business in a way
that is better than anyone else’s model.
The major firms then are mainly coordinators, integrators of the specialist
firms, and the branders of the final products. This might be, for many industries,
the business model of the future. It would not be the first time that media has
led the way for a general business transformation.
The printing press led the way for an industrial mass production system.
Perhaps the film industry model, created in the Darwinian process described, is
a forerunner for the next stage: the post-industrial production system and
economy.
154
DISCUSSION QUESTIONS
1. What is the effect of vertical integration and supporting industries (books, toys, music, games) on the success of Hollywood franchises?
2. What media production industry (book publishing, Hollywood, TV, video games) is least dependent on the others? Why? Is that an advantage or disadvantage?
3. Can lack of diversification be used as a risk reduction technique? When and how can it be successful, if at all?
4. What accounts for the high selectivity of the book industry since even bestsellers have the lowest investment cost when compared to blockbusters of other major content production industries?
5. Which characteristics of major non-Hollywood industries (automobiles, manufacturing, services) should Hollywood adopt to better itself?
6. How can one define and measure productivity in content production? Is it increasing?
7. How will advancements in technology influence the future of film production? Newspaper production?
8. How can the European film industry become more financially successful? Why, in contrast, are European book publishers more successful?
9. Is the Hollywood production model a suitable model for other industries of the economy? For which?
10. What are the ingredients of successful content production in music? What do they suggest for content production in general?
155
11. Can content production be organized on an industrial scale? How can mass production accommodate individualized creativity?
12. Where can production processes from industry be applied to the content industry?
156
Tools
We reviewed management tools:
• Portfolio diversification for content
• Project selection & valuation
• Queuing models
• Process flow diagrams
• Linear Programming
• Critical Path Methods
• PERT
• Release Sequence
• Gantt Charts
We covered content production, specifically film, in its dimensions of:
• Diversification
• Financing
• Distribution
157
• Development
• Integration
• Budgeting
• Specialization & Clustering
• Risk reduction
• Industry structure
• Industry & Technology
• Talent
Risk Reduction Strategies:
• Diversification of content
• Selection of content
• Insuring movies
• Budgeting
• Integration
Issues Summary
158
• Hollywood Advantage (reasons for Hollywood success)
• Production Types
• Film industry history
• Film industry worldwide
• Book industry history & production
• Music industry & production
• Video game industry & production
• Software industry & production
• Theater industry
• Industry Structures
o Specialization
o Industry clustering
o Management
o Vertical Integration
• Print Process
• Hollywood input factors
o Funding and financing of Hollywood projects
159
o Role of stars
o Role of technology
• Productivity
• Production process
• Future of content production
160
