Why The Film Business Doesn't Face The Same Fate As The Music Business

For years, there has been a steady stream of of articles reporting the continuing decline of the recorded music industry. Everyone knows the saga by now.  As music became available on the Internet, people stopped buying CD's and younger listeners started freely copying song files from one another.  A whole generation of consumers now has the idea that music should be free, and sales of recorded music continue to decline.

All of those facts are pretty accurate, but there is one element of the story that is often left out, and it has a lot to do with why the music business can't get back to its prior levels of revenue.  Record companies were primarily in the business of selling albums -- groups of 10 or 12 songs.  Back in the "old" days, the normal price of an album was around $15.00, give or take a few bucks.  That meant that the price per song was a dollar or two -- much like it is now -- but the unit sale was much higher.

The magic in that model was that a record company could promote one good song off the album, and consumers would have to buy the rest of them too.  Think of it in another context.  You're hungry for a hamburger, but you have to buy 11 fish sandwiches at the same time in order to get your hamburger.  McDonalds would sell a lot of fish sandwiches that way, even if no one really liked fish sandwiches.

In reality, with the retail price of a recorded song about where it's always been, the gross profit margin is actually higher.  There are no manufacturing, shipping or co-op placement fees. Same revenue, lower costs -- that means more gross profit to go around.  But the problem is that this new model of distribution doesn't let the record company sell a bunch of fish sandwiches along with the burger.

With the demise of the DVD, there is a real fear that the film business will face the same sort of irretrievable decline in revenue from the home entertainment division.  While the problems of illegal copies and piracy are certainly a similar challenge, the film industry isn't faced with a prior business model that had them selling 10 or 12 movies per disc.  So as film distribution moves from discs to digital downloads and streaming, film distributors are still going to be selling in the same units as before -- one film at a time.  And all of the economic efficiencies of digital distribution should work in the same way to actually increase the profit margins.

I understand there are many other factors in play.  Films are expensive to make (although less expensive than they used to be), and there might still be a perceived value issue where consumers won't pay as much for a download or stream as they will for a disc.  However, with all of that said, at least the film guys aren't trying to reclaim a business model where most of their sales were from products that no one ever really wanted to buy.

A New Era In Home Entertainment Started Today

With Amazon's entrance into the streaming business, the horses are officially out of the gate in the new race for home entertainment dominance.

My buddy, Jack Wrigley, emailed me today to point out the importance of Amazon's acquisition of LoveFilm which has allowed the Internet retailer to magically turn its Prime subscription shipping service into a film-streaming service. With the flip of a switch, Amazon becomes a force to be reckoned with in digital entertainment. 

In light of that development, I think it is fair to say that this week marks the real beginning of a new era in home entertainment.  Up until now, Netflix has been in a massive proof of concept stage, showing the world that there is money in streaming movies into homes.  Prove the concept they did, becoming a $2+ billion business in the process, with massive growth still ahead.  And then within a 24 hour period, Blockbuster acknowledges that its business cannot be revived and agrees to sell the remnants for less than $300 million, and Amazon makes its bold move into Netflix' streaming space.  Oh yeah...and Redbox is shouting a distant "Me too!" from its post in front of the 7-11 stores.

In saying a quick and fond farewell to Blockbuster, I can only note that its market value less than 10 years ago was over $5 billion.  It lost about 95% of that value sitting on its hands while Netflix took advantage of predictable (inevitable, really) changes in the home video market.  It is perhaps the most blatant case of corporate arrogance I've seen in my adult life.  There are plenty of lessons to be learned from that tale.

Redbox jumped into the home video game for some short term profits, with a model for better price and convenience that was never as good as the Netflix solution.  It was good enough to beat Blockbuster's rusty model, but Redbox ignored the obvious pending impact of digital delivery.  Redbox uses the Internet for payment and inventory control on its machines while it continues to deliver its films in a dying format.  It's somewhat convenient because the discs are available 24 hours a day in places where consumers already go, and you can return the discs whenever you want to any Redbox machine.  If there was no such thing as digital delivery of content, it would be a great business.

Of course, Redbox is a division of Coinstar -- a vending machine company.  Redbox was designed as a strategy for placing more vending machines, not for giving consumers what they really wanted.  It's a perfect example of a supply-driven strategy as opposed to a market-driven strategy.  It only works well so long as you happen to be supplying something the market wants.

Reed Hastings

Netflix was born as a market-driven company.  Its mission was to ease consumers' pain over late fees at Blockbuster.  It also started as a disc-renting company.  Its subscription model and cool envelope design were the initial competitive advantages.  But Reed Hastings is a software guy; he understands the power of digital technology.  More important, when he sees changes coming, he embraces them -- in fact, he jumps ahead and lets the world catch up to him.  That's what successful people do.

So, he focused on creating a superior web interface that his customers could use to line up their disc orders.  Then, with the flip of a switch (and some new contracts), he let them start watching the films right on their computer.  When the inevitable convergence of Internet and television finally arrived, there was Netflix (and its 20 million users) already eating popcorn on the couch.

Jeff Bezos

Jeff Bezos at Amazon is another visionary guy who truly understands the power of technology.  His company also has one of the best user interfaces on the Internet, and a massive number of loyal customers.  Amazon jumped into the digital streaming business in a pretty timely manner, but its pricing model reflected its "unit sale" roots.  With today's move into a subscription model, Amazon is officially acknowledging that consumers don't prefer to rent their entertainment in single unit packages.  Amazon has 10 million Prime members already paying an annual subscription fee.  That's a pretty good start at chasing Netflix for movie streaming dominance.

And while Redbox publicly acknowledges that it needs to be in the subscription streaming business, it is lacking some key elements.  First, it has no cool website as an integral part of its existing model.  There is no installed user base already making online payments, and no superior user interface.  It's a vending machine company.  No one wants to stream videos in front of their local 7-11, and that's where Redbox lives.  Again, this was predictable; if they wanted to be in people's homes, they should have built their model with a home-based component.  They didn't do that.

So, the bell has sounded and the race has officially begun.  In addition to Netflix, Amazon and Redbox (at the back of the pack), there is Hulu and Google/Youtube and Vudu and Apple and others.  Plenty of horses to bet on.  The winners will be determined by their ability to navigate their way onto consumers' televisions, their ability to cut the right deals with studios and other content owners and creators, and good old-fashioned marketing.

And as always, the winners will be the companies that can see around the curve, getting ahead of the trends and letting the rest of the world catch up to them.  There is no way to win by chasing someone else's success in today's entertainment business.  True vision and innovation are the only paths to long-term success in the new digital environment.  Blockbuster learned that lesson the hard way, and there will be more casualties before it's over.

Broadcast Network Trend: Being The Brand!

Broadcast and Cable Outlets Supplement Ad Revenue By Becoming Their Own Brands.

There is a fascinating trend going on in the world of broadcasting.  Networks are recognizing that their own names and logos have market value that goes beyond merely attracting viewers.  This isn't just a theory, as manufacturers of products are paying real dollars to carry the trademarks of outlets like E! Entertainment, Style and The Food Network.  If you analyze it for a minute, it actually makes sense.

Before cable came along, there were a limited number of broadcast outlets in each market.  This is because the signals all traveled through the air, and there were a limited number of frequencies to carry different broadcast channels.  With the advent and expansion of cable, viewers came to have many more choices.  And when digital cable came along, this expanded again.  And now with online media moving to the television set through AppleTV, GoogleTV, etc. etc., the number of choices is officially infinite.

In a universe of many choices, it is necessary for each outlet to focus on a niche in order to survive.  It happened in the magazine business first -- where the newsstand went from carrying a relative handful of broad interest publications to carrying hundreds of very specialized publications.  That is the same pattern that emerged as more and more cable stations came on line -- each station worked to be a leader with its own special audience.

In focusing on a particular niche and becoming the leading source of information and programming with a particular group of consumers, a media outlet develops independent credibility that goes beyond the programming or ads that it carries. People start to think of themselves as liking to watch The Food Network, as opposed to just being a fan of Guy Fieri or Ace of Cakes.  The network itself begins to stand for something -- it becomes a brand.  

So, in a logical and intelligent response to competition, broadcast and cable outlets have positioned themselves as having a particular meaning with a specific audience.  Once that is successfully accomplished, it only makes sense to capitalize by "lending" that credibility to other products -- for a price, of course.

I actually think I like this trend.  It allows broadcast outlets to supplement their income without selling more ads or putting cans of Coke and other products in the middle of every show.  It is an indicator of successful marketing and perhaps even helpful to consumers in identifying products which are consistent with their own tastes and interests.  Bravo!  

(That last line was funny, you see...because Bravo is the name of a network... and the post was about names of networks... funny, right?   Ok, sorry.  You're right.  That was a bad pun.)

Pandora: A Good Bet for Wall Street?

With an IPO currently scheduled for later this year, is Pandora sexy enough to attract investors?

This week, Internet radio company, Pandora, filed its application to sell stock to the public.  If you read between the lines, the application may be more of a publicity move than a financial milestone.

There is no doubt that Pandora could use the $100 million it hopes to raise.  The company is still struggling to become profitable.  And therein lies the conundrum.  Investing in a losing venture only makes sense when the capital infusion will turn the company around.  But I don't think Pandora is struggling because it lacks money.  The problem seems to be its business model.

Pandora's competitive advantage -- the strength which it sells to consumers -- is its psycho-tech music measurement software.  It is something out of a science fiction movie -- software that allegedly understands exactly why you like particular songs.  The theory is that Pandora can turn every listener on to more music that is exactly what he or she wants to hear.

I'm not even going to argue whether the software works.  I'm willing to assume that it does -- at least to some degree.  If they work that hard to analyze the music I like, they can probably find some more songs that will appeal to me.  The issue is whether anyone will ever pay for that service.  Unfortunately, I don't think so.

I think all of us like to discover new music in a more organic way.  We ask our friends or simply stumble across it.  In fact, I think we enjoy the process of listening to something and deciding whether we like it or not.  We don't need the pressure of software telling us that this is music that is scientifically matched to our tastes.  I personally don't like to think of myself as being that predictable -- even to a computer.

And even if I like the idea of getting a bunch of new music chosen (if computers actually "choose") just for me, I can't see paying for it.  I'll subscribe to Netflix for 8 bucks a month, but not to Internet radio -- no matter how smart it is.  And that's why Pandora is free, and why it will probably continue to be free.

That means that its only likely real revenue source is some version of an ad-based model.  It might find its way to profitability by selling ads, but I don't think it will enjoy explosive growth.  And with music royalties and other costs likely to increase, the road to profit will only get steeper.  (In fact, Pandora is apparently no longer available in Canada because the music license fees were too high.)

Pandora is certainly getting a lot of buzz.  It now has over 80 million users and is constantly mentioned as one of the hottest companies on the Internet. By filing for an IPO, it is trying to tell the world that its momentum will eventually lead to riches.  Personally, I just don't see it.

Without a huge upside, there is probably not a lot of incentive for investors to jump on board.  The idea of investing in an Internet stock is to bet on the home run, and Pandora doesn't seem to have enough power to hit it out of the park.  

I'm open to other points of view.  Let me know if you think I'm missing something on this one.

This Is The Year The Indie Film Business Starts To Come Back

I was going to title this post with a question - asking if this is the year the indy film business starts to climb out of its doldrums.  But in truth, I am writing about it because I think there is no question.  This is indeed the turn around year.  Here's why I feel so optimistic:

Obviously, the volume of sales at Sundance was a big positive.  Since 2008, Sundance sales had been in the dumps, falling to only 10 sales in 2010.  This year the number was almost 4 times that amount.  Both of the 2011 Sundance films that I worked on sold to great distributors in very favorable transactions.  I found that personally encouraging, but that's not what sparks my optimism.  It is the overall willingness of a number of different distributors to risk their dollars on a variety of films.  This is a broad showing of confidence from smart people with their hand on the pulse of the industry.  That means a lot.

Another positive factor is the tipping point in the evolutionary metamorphosis of the home video market.  The grieving over the death of DVD's seems to be subsiding, with the rise of Netflix, Hulu, CinemaNow, Amazon, iTunes, Vudu and other streaming services helping to dull the pain.  While the revenue from these services has not filled the hole left by the collapse of the DVD market, there is now a clear path to profit.  In fact, once the market penetration of streaming rises a bit further, it will be a much more profitable model for delivering films to consumers' living rooms. 

The other part of the home market that is perhaps even more exciting is mobile distribution.  There were 80 different tablet media devices exhibited at the Consumer Electronics Show this past month.  There will be millions and millions of these devices in consumers' hands this year, and the numbers will continue to rise dramatically for years to come.  This is a new market for films that has never really existed.  Certainly some consumers were using portable DVD players, but that was all part of the DVD market.  Tablets facilitate distribution in a way that should greatly expand the amount of mobile viewing.  And it facilitates support from sponsors and advertisers in a way that DVD players could not provide.  This has to result in an economic boost.

And none of this is at the expense of the theatrical business.  Theaters are doing well; consumers continue to enjoy the theatrical experience and average ticket prices are inching up.  (A lot of that is the result of 3D and bigger studio films, but the indie business still benefits as audiences show up at the multiplex and a certain number of them will choose to see smaller, critically acclaimed films.)

Clearly, the revenue picture for the film business is stabilizing and actually looking pretty favorable in terms of future growth.  That is the factor that will bring investors back into the game, raise the minimum guarantees, bring lenders back to the table and generally free up some financing to start making more movies.

There are two possible negatives.  One is a potential decline in state incentives.  States are very tight on money and it is possible that a significant number will pull back or even eliminate their production incentive programs.   If that happens, the money will be difficult to replace.

The other challenge is that budgets have been squeezed pretty hard.  The films I'm working on have much lower budgets than five years ago.  While better technology has created production efficiencies that take up part of the slack, there are still limits on how ambitious most independent productions can be.  This means that certain films will still be difficult to make.

With all of that said, I remain confident that we will begin to see an improving environment for independent film production.  It won't be a meteoric rise in activity, but it should definitely start heading the right direction.  So dust off some of those scripts that you abandoned a couple years ago.  It might be time to take another shot at getting them made.