The Hollywood Economist

Downloading for Dollars

The future of Hollywood has arrived.

Next wave? … or tsunami?

Once upon a time—two generations ago—the movie business was about making movies. Nowadays, it is about creating intellectual property that can be licensed in a raft of different markets. The Hollywood studios still make movies, of course, but by 2005, only 14.2 percent of their revenues came from movie ticket sales, while 85.8 percent came from licensing or selling their products for use in the home. (Click here for the studio revenue numbers.) Until 2005, the studio’s principal access to the home market came through pay TV, free television, video rentals, and DVD sales. But now, with products such as Apple’s video iPod and TiVo-type digital recorders becoming widely available, Hollywood is inching toward an even more lucrative way of exploiting the home market.

Disney’s ABC network has already made a deal with Apple that will allow iPod users to download and watch shows, such as Desperate Housewives, for $1.99 an episode. The company has also been talking to Comcast about a similar pay-per-view arrangement for Comcast’s 23 million cable subscribers. CBS, which is still controlled by Sumner Redstone, and NBC, a subsidiary of NBC Universal, have announced plans to release their programs for 99 cents a viewing whenever a customer wants to see them, through linkups with cable and satellite providers. Meanwhile, the satellite giant DirecTV, which Rupert Murdoch controls, is in the process of equipping its 12 million subscribers with TiVo-like digital video recorders that have extra storage capacity for eight hours or so of programming. Fox, which Murdoch also owns, can then download its shows onto an encoded section of subscribers’ hard disks, which they can pay to view.

This downloading strategy is particularly appealing to the broadcast networks. Under long-standing FCC regulations, they have the right to negotiate with cable operators about carrying their programming. But, the broadcast networks rarely receive cash payment—instead they are compensated with such things as free ad time. Cable networks, such as ESPN, who are under no such mandate, get paid a hefty “carriage fee” for allowing cable operators to show their programs. * The networks, by offering their hit programs for downloading the next day, could also cash in on the cable audience. A cost of 99 cents a pop is hardly trivial when multiplied by an audience of 23 million Comcast subscribers. The networks are assuming—and this remains to be tested—that their regular audiences, which can watch the programs free, would have little incentive to wait a day and download them for a fee.

The studios stand to gain even more from a huge audience willing to pay to download movies from their libraries. Unlike DVDs, which require manufacturing, warehousing, distribution, and disposing of returns, it costs almost nothing to download a movie or cartoon. Indeed, all the costs of transmission would be born by the cable operator (or a site like the Apple Music Store), whose cut would be less, under present arrangements, than retailers get on DVDs. So, if a movie were a huge hit, such as Shrek, and millions of orders flooded in, the marginal cost of filling them would be zero. The consumer, once he bought the download, could watch it where and when he chose to just as he once watched a DVD.

The real issue for the Hollywood studios is how they can dig into this potential gold mine without undermining their existing revenue streams. Since the 1980s, the studios have managed their revenue by employing a system of “windows” to release their products to different markets. First, movies play in theaters, then, six months later, the video window opens, followed by the opening of the pay TV and then free television window. But giant retailers, to spur their seasonal sales, have been demanding their DVD delivery earlier and earlier, and they’ve thrown this system into turmoil.

With the possibility of costlessly providing millions of downloads to consumers of both their older and new films, the studio heads, including Disney’s Robert Iger, are openly discussing radically revamping the window system. Obviously, if a home download of a movie were available at the same time (and price) as its DVD release, the download option might replace retail sales. To avoid that outcome, and a potentially dangerous confrontation with Wal-Mart, the studios would have to delay the download release until well after the DVD release. But while the studios may find this embarrassment of choices somewhat paralyzing at present, as more and more consumers get digital recorders or video iPods, downloading for dollars may prove irresistible—even if it means doing away with the windowing system.

Hollywood’s downloading option, by whatever device it may be realized, is just one more part of the transformation of movies from a big- to a small-screen experience and from a theatrical to a home—or even mobile—product.

*Correction, November 29, 2005:This article originally and incorrectly stated that the FCC required broadcast networks to provide their regular programming free to cable operators. In fact, the FCC gives broadcast networks the right to negotiate with cable operators, but the result of such negotiation is rarely cash payment. The Hollywood Economist thanks reader Andrew Schwartzman for pointing this out. Click here to return to the corrected sentence.