The Hollywood Economist

Dumb Money

The madness of movie advertising.

Consider the perverse logic of Hollywood: In 2003, the six major studios—Disney, Warner Bros., Sony, 20th Century Fox, Universal, and Paramount—spent, on average, $34.8 million to advertise a movie and earned, on average, just $20.6 million per title. Even if the studios had made the movies for free—which, of course, they didn’t—they would have lost $14.2 million per film on the theatrical run, or what the industry calls “current production.” Given the fleeting attention span of the target audiences (mainly TV-watching teens) and the unmemorable nature of the ad copy, the studios believe they must show the same ad on the same programs at least eight times in order to draw an audience. As a result, the studios spend more to lure a teenager into a theater than they receive at the box office, which is reminiscent of the joke about the idiot in the garment business who “loses money on every sale but makes it up on volume.”

The moguls who run New Hollywood are anything but idiots, however, so, after I was given access to studio budgets, I asked a very savvy executive at 20th Century Fox how the studios recover this huge advertising expenditure. He explained that big opening-weekend numbers, even if they are expensively acquired, may pay off in later markets—specifically video, pay-TV, and foreign release. At that time, the year 2000, he was right: Video chains like Blockbuster mechanically pegged their orders, which could range from 1,000 copies to 300,000 copies for a single title, on the results of the theatrical opening. So did pay-TV channels, such as HBO. And, since movies were typically released overseas many months after their American debuts, studios could use impressive U.S. box-office numbers to wrangle more advantageous play dates in foreign markets.

Since then, however, the digital revolution has radically changed the movie business. The video rental market, which had been the studios’ cash cow as late as 2000, is rapidly disappearing. It’s been replaced by the business of selling DVDs in which a handful of mass retailers, such as Wal-Mart, account for most of the studios’ revenues. Unlike the video chains that rented videos, the big retailers don’t simply peg their orders to a film’s box-office results. Instead, they view DVDs as traffic-builders: The stores use them to lure in the relatively well-heeled, plasma-screen-purchasing customers—who are usually not the so-called LICs (or low-income consumers) who are recruited by ads for movie openings. As a rueful Sony marketing executive pointed out, “Unfortunately, our teens are not always who they want.”

In addition, unlike the video-rental business, the studios pay the full costs of returns: DVDs can be returned by stores after 60 days if they do not bring in the desired traffic. Returns can be very costly, as DreamWorks Studios recently found when it got back 7 million copies of Shrek 2. DVDs also changed the equation for pay-TV channels. Customers who own high-quality DVDs of a movie are less likely to pay to see the same movie six months later on Showtime. So, the pay-TV channels substituted original programming, such as The L Word, and greatly reduced the amount they paid for box-office blockbusters—making impressive theatrical numbers even less of a factor.

Finally, the digital revolution has a dark side—zone-free DVD players, DVD piracy, and Internet file sharing—that deeply alters the scenario for foreign distribution. Because movies can now be illegally circulated around the world the instant they open in the United States, the studios have begun to abandon their practice of staggering foreign openings. As a Fox vice president told Variety in 2005, “Waiting three or four months after domestic [release] to release our bigger pictures [overseas] is not something we can do anymore.” The latest episode of Star Wars opened on the same weekend in the United States and in 59 other countries. With these simultaneous openings, the U.S. box office obviously came too late to help get better foreign play dates.

All of these changes add up to a growing disconnect between the money poured into advertising for a large theatrical gross and the earnings realized in the markets that the studios depend on for their money. (Click here  to see the money machines.)

Does Hollywood need to remain so out of synch with reality? At present, the studio marketing arms have become exceedingly efficient at stampeding weekly herds of teens to multiplexes and producing impressive numbers. But if that amazing trick turns out to be not worth its average $34.8 million price tag, studios will have to consider different strategies. The most obvious one would be to eliminate the long interval between a film’s opening and its release on DVD. Also, if the studios aimed at the much larger and more profitable DVD audience, they would not need to spend so much on the teen herd. In this regard, Mark Cuban and Todd Wagner, who own the Landmark Theatres chain, the distributor Magnolia Films, and the high-definition cable channel HDNet, have announced just such a radical strategy. They will finance six movies directed by Steven Soderbergh and release each one simultaneously in movie theaters, pay-TV, and on DVD. To follow suit, the Hollywood studios might also need a different class of movies.