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.

As DVD's Die, How Will The Film Business Fare?

Here is a pretty good article that discusses the shifting trends in the in-home distribution of films.  Obviously, the trend is away from DVD's and moving towards direct delivery.  In fact, the shrinkage in the DVD numbers is pretty dramatic.  The DVD is going the way of the CD.

Blu-ray is making up some of those losses, but Blu-ray will eventually follow the same path.  Right now Blu-ray discs are popular because there is no real alternative for super-HD resolution.  But when a Blu-ray quality file can be easily and quickly downloaded right to your big screen TV, there will simply be no reason to mess around with a disc.

Discs are dead.  However, the download and video-on-demand markets are expanding pretty quickly.  None of this is news, but what does it really mean?

For disc manufacturers, it means they should already have shifted their focus to other businesses.

For distributors, the ability to warehouse and handle large amounts of physical product will not be useful much longer.  The distribution of content is still a very good business, but moving digital files is very different than moving discs. The good news for distributors is that the profit margins should increase dramatically as all of the costs of moving physical inventory evaporate.

Producers still need to produce great content.  Consumers will always want good stories that are told well.  However, production is both cheaper and trickier.  As more people use iPads, smartphones and similar devices to watch films, the productions will need to translate from very large screens with huge speakers (like IMAX) to the small screens of a smartphone with headphones.  That's challenging.

The real issue for those of us on the business side is whether the revenue from new sources such as download, streaming and mobile will replace the dwindling DVD market.  I believe the answer is "Yes" if you look at the profits.  The revenue might go down, but so will the costs of delivery.  That means that even if volume is lower,  the profits will be higher and hopefully make up the difference.

Direct delivery of content is a more efficient system than any physical media.  The benefit of those efficiencies should be apportioned in some manner among all of the stakeholders, from consumers up the chain to producers.  I think natural market forces will cause that to occur, and at the end of the day, the film business will be healthier than ever.  Higher profits means it's a better business model.

Technology and The Collapse of Distribution Windows

An article in today's Variety details efforts by the MPAA to help its members gain the ability to broadcast first-run movies directly to consumer's homes. The article raises a few issues:

1. Apparently, approval from the FCC is needed for the MPAA members to use DRM protection on the broadcasts. Not surprisingly, the studios would be unwilling to give consumers access to broadcasts of first-run features without technology that prevents copying of the content.

2. Exhibitors are opposing the MPAA's efforts because there is a strong suspicion that the films would be broadcast during the first-run exhibition window. Exhibitors view this as a huge threat to their business. Logic dictates they are probably right.

3. A point not really addressed by the article is the impact of this action on the other distribution windows. Doesn't an early broadcast of the film essentially eliminate (or at least substantially devalue) the VOD, Cable and DVD windows?

It would seem that the studios are attempting to set up a model that eliminates as many middlemen as possible. Essentially, this goes back to the old days where the studios actually owned the theaters. They would make a movie and then have consumers pay the studio directly for the right to watch it.

The direct studio broadcast model being pursued by the MPAA is the digital-age version of studio-owned theaters. The studios can make a film and deliver it directly to consumers. However now consumers don't even have to leave their favorite chair to watch the film.

Here are some arguments on the studio side. Many knowledgeable people in our industry say that home viewing is not competitive with the theater experience. The superior size and quality of theater exhibition, together with the opportunity to get out of the house to do something fun, make going to the movies an "event." Plus, the social aspect of watching the film in a group of people definitely provides an energy that is impossible to duplicate in your living room. Bottom line -- many people will still go to theaters to see films, even if they can get the same film in their home.

Further, showing a film simultaneously to theater audiences and home audiences allows for a consolidation of marketing dollars. This means that the overall spend on advertising can be less, making it easier for the filmmakers and studios to make a profit. This ultimately should allow studios to release more pictures, giving consumers a wider range of attractive choices.

Further still, if studios can lower distribution costs by eliminating middlemen, this ultimately serves consumers. The essence of our economic system is to encourage business models which drive prices towards their natural bottom -- the real value of the product or service being provided.

However, when a single company controls the entire chain of a product or service, from development to delivery, it might have the ability to lower prices to consumers, but it has no economic motivation to do so. When it is not competing at any point in the process, it can charge whatever it wants. This is called a vertical monopoly and it is technically illegal. The argument could be made that direct delivery of content by studios is a violation of antitrust laws. (I'm not sure this is a winning argument, but it is an argument nonetheless.)

Certainly, if studios broadcast first-run features directly to consumers day-and-date with the theatrical release, it will have a huge impact on the current "windows" which are the essence of modern-day film distribution. I'm normally a proponent of change because I believe it often creates new opportunities as the old model dies. However, I'm not sure that's true in this case. Giving studios even more control over the delivery of film content does not seem to serve consumer interests. There are no new opportunities which will arise as a result -- unless someone has a really good idea for a way to use a bunch of empty movie theaters.