The Hollywood Economist

The Iger Fatwa

Does it mean goodbye to the movies?

Robert A. Iger, who will replace Michael Eisner as the head of Disney this month, has already gone public with Hollywood’s hot-button issue: realigning the studio “windows.” The windows in question are not the corner-office views at Disney headquarters but rather the system of time windows that Hollywood has employed since the 1980s. The so-called video window, for example, provides for a several-month delay between a movie’s theatrical release and its DVD release. Similar windows for pay-per-view and television allow the studios to milk the maximum amount of money from each of their titles. “We have to look at window changes … across the board,” Iger said, adding, “Windows need to compress. … I don’t think it’s out of the question that a DVD can be released, in effect, in the same window as a theatrical release.”

While studios have been privately debating for months about how to change the window system, John Fithian, the president of the National Association of Theater Owners, was stunned that Iger broached the issue publicly. He immediately shot back that Iger’s proposal was tantamount to a “death threat to our industry” and attributed this summer’s decline in theater attendance—and other “short-term peaks and valleys” at the box office—to the uneven quality of Hollywood’s movies. His view, echoing that of theater owners, is that popular behavior has not changed, and that the solution to falling attendance is better movies. Will this remedy work for Hollywood? Before answering this critical question, two pesky misconceptions must be cleared away.

First, despite this summer’s nervous, mournful headlines, a yearly decline in attendance is not an extraordinary event—it has been, at least for the last 56 years, the norm. Since the availability of television in 1948, there has been an annual decline in movie theater attendance in most years, with a drop in some years of more than 800 million tickets sold. While attendance has zig-zagged up and down, the direction, if not pure free fall, has been decidedly downward. Annual attendance, measured by ticket sales, has dropped from $4.68 billion in 1948 to $1.54 billion in 2004, even though the American population nearly doubled during this time period. Americans are now going to movies less than one-sixth as many times per capita as they did in 1948.

Second, the theater business is very different from Hollywood’s business. The multiplexes make almost all of their money from selling tickets—from which they split the proceeds with the studios—and from selling popcorn, soda, and other snacks, from which they make as much as 90 cents of profit on every dollar spent. As one chain owner explained to me, “The more people we move past the popcorn, the more money we make.” This flow of revenue—especially the lucrative popcorn traffic—is threatened whenever ticket sales decline. As theaters cannot cut their major costs, such as rent, insurance, and debt service, they cannot maintain their profitability. A 6 percent worldwide attendance drop between 1999 and 2001 left nearly half the theaters in the world seeking bankruptcy protection. Now, with the DVD being aggressively sold by mass retailers, theater owners see the “video window” as a crucial defense against the erosion of the theatrical audience. The prospect of removing the video window is indeed a “death threat.”

Studios, for their part, are involved in a much more diverse enterprise than theater owners. American movie theaters account for 7.2 percent of the studios’ total revenue, and world theaters only 14.2 percent of their revenue. The rest of their profit comes from people watching DVDs, TV movies, and other studio products at home. And no wonder: Fewer than 2 percent of Americans now go to movie theaters on a given day, while more than 95 percent watch something at home on TV. To ensure access to this home audience, the corporate parents of the studios own all six television broadcast networks, as well as most of the large cable networks.

Unlike the bygone studio era in which the job of the legendary studio heads was to produce box-office hits, today’s studio CEO is expected to optimize the deployment of the studio’s assets across the whole spectrum of the entertainment economy. Consider, for example, the 10-year regime of Jonathan Dolgen and Sherry Lansing at Paramount. Even though they had a dearth of box-office hits that the media dwelt upon, they tripled the studio’s profits by, among other things, launching a TV network (UPN), establishing two new film divisions (MTV Films and Nickelodeon Films), doubling the number of titles in the studio’s library through acquisitions, creating theme park attractions (the Star Trek ride), recapturing Paramount’s international video distribution from an off-the-books partnership with Universal, and creating an elaborate system of foreign tax shelters and government subsides to finance movies.

The relentless pressure to increase earnings pushes executives to upset the status quo. One top executive candidly explained that studios, including his own, reduced the video window from six months to four months “solely to satisfy quarterly profit goals.” The shorter interval boosted their earnings by allowing them to release their midsummer movies on DVD during the peak sales periods of Thanksgiving and Christmas.

This brings us to Iger’s fatwa. Disney is currently considering a stunning proposal from Brian Roberts at Comcast that could reshape the entire windowing system. Roberts’ company is the world’s largest cable operation, and he wants to run Disney’s hit television programs, such as Desperate Housewives, Lost, and Grey’s Anatomy, on his cable system just 24 hours after they play on Disney’s ABC network. Comcast’s 21.5 million subscribers would be able to view these programs on demand without commercial advertising. Roberts would also like to add movies to the service, a gambit that would quickly undermine all the existing separations, or windows, in the entertainment economy. For Roberts, Disney’s hits would give him an edge in competing for subscribers with Rupert Murdoch’s satellite TV empire. For Iger, the huge amounts of money Disney would receive from Comcast for each episode, which could be as much as $500,000, would go directly to its bottom line. In this context, Iger’s statement that “windows in general need to change” was not so much a death threat as a wake-up call to a new reality in which theater owners will have much less of a protective window against digital competition.

Such a fundamental change in Hollywood’s business model might allow the studios to initially harvest more money from home entertainment. Fithian argues, however, that without movie theaters to establish movies, collapsing the video window would ultimately “devalue Hollywood movies” for even the home audience and turn the studios into mere vendors of “movies-as-commodities-only.” But are “better movies” a realistic alternative for the New Hollywood? The most prolonged decline in Hollywood’s history, from 1963 to 1973, in which the weekly audience dropped from 43.5 million to 16 million, was not stemmed by such critically acclaimed films as Mike Nichols’ The Graduate, Francis Ford Coppola’s The Godfather,Stanley Kubrick’s 2001: A Space Odyssey,Arthur Penn’s Bonnie and Clyde, David Lean’s Doctor Zhivago, George Lucas’ American Graffiti, George Cukor’s My Fair Lady,and Stanley Kramer’s Guess Who’s Coming To Dinner. More than $1.4 billion in theater admissions a year were lost. Nor would such quality movies bring in the popcorn consumers on whom the multiplexes now depend.

Theater owners define “better” products differently than cinephiles. They want amusement-park extravaganzas loaded with special effects that appeal to their popcorn-crunching audience, such as Star Wars, Jurassic Park, Pirates of the Caribbean, Spider-Man,and Terminator 3. They also want the saturation television ad campaigns that activate the audiences for these films. Yet, since these “better” amusement-park sequels do not come cheaply—Terminator 3 cost more than one-quarter billion, $187.3 million for the film itself and $69 million for prints and advertising—they may provide less of an ultimate solution for studios than for the multiplexes. Studios, after all, have other ways to invest a quarter billion dollars of scarce capital—for example, Time Warner HBO’s 10-part Rome series, which it has already begun to release on DVD. The new generation of moguls is far more open to business school-type “optimization,” a concept that assumes higher earnings in one area can substitute for lesser ones in another area without permanently damaging the whole business. For example, gains in shortening the DVDs and video-on-demand windows could more than compensate for lower earnings (or even losses) at the box office. However, not everyone in Hollywood agrees that optimizing the windows will sustain the theater audience, even at a modest level. “The theatrical business is like glacial ice,” one of the savviest of the remaining Moustache Petes said. “It won’t just gradually melt away, it will suddenly break off.” If so, it may be goodbye movies—as we know them.