Hollywood Creative Accounting: The Success Rate of Major Motion Pictures

The “Net Profits” of Motion Pictures

The distributor not only manages but also actually drives the process of sharing the income of a movie between parties.[26] In fact, even though distributors compete for the services of established and successful producers/directors, ultimately the distributor is the stakeholder with the most significant degree of bargaining power. As a result, producers commonly pay generous fees for various services to the distributor and other branches of the same info-entertainment conglomerate. In the calculation of net profits according to the definition presented in this section, namely, from the viewpoint of the producers, these fees represent expenses paid to third-party companies.

• (III.) NET PROFITS (OR LOSSES) OF A MOTION PICTURE
• • = GROSS REVENUE (IV) − TOTAL NEGATIVE COST (XII)

A Motion Picture’s Gross Revenue

• (IV.) GROSS REVENUE (PRODUCER) OF A MOTION PICTURE
• • = BOX OFFICE RENTAL (V) + HOME VIDEO REVENUE (VI) + REVENUE FROM TELEVISION (XI)

The gross revenue of a motion picture is calculated in this exercise as the sum of the box office rentals, the video revenue (rental and sales), and the revenue generated by TV licenses in domestic and international markets. This section explains the details of the methodology followed in order to estimate these variables. The gross revenue should also include the income generated from the ancillary and new media windows; however, due to the lack of data, these sources are not included in the definition of gross revenue used for this exercise.[27]

• (V.) BOX OFFICE RENTAL OF A MOTION PICTURE
• • = 50% OF BOX OFFICE (DOMESTIC* + INTERNATIONAL*)

The estimate of the box office rental (the share of the box office paid by the exhibitor to the distributor), is calculated here as 50 percent of the sum of DOMESTIC TOTAL GROSS BOX OFFICE and FOREIGN TOTAL GROSS BOX OFFICE (both imported variables). Notably, there are different types of contracts used to share this revenue between exhibitors and distributors, but a 50 percent split between these two stakeholders is the current norm.[28] Previous standards, such as the “90/10 minimum-guarantee deal,” on the other hand, allocated a smaller share of the box office to the exhibitor (i.e., that 10 percent) in addition to a negotiated fixed-house allowance. Nonetheless, as this share increased, for films kept in the theater for more than two weeks, using 50 percent of the box office as an estimate of the gross film rental is generally considered a reliable “rule of thumb” for the period under study.[29]

• (VI.) HOME VIDEO REVENUE OF A MOTION PICTURE
• • = 20% OF WHOLESALER’S GROSS HOME VIDEO REVENUE (VII)
• (VII.) WHOLESALER’S GROSS HOME VIDEO REVENUE
• • = 60% OF THE GROSS HOME VIDEO REVENUE (VIII)
•  [40% IS KEPT BY THE RETAILERS]
• (VIII.) GROSS HOME VIDEO REVENUE OF A MOTION PICTURE
• • = DOMESTIC DVD SALES* + DOMESTIC DVD RENTALS* + INTERNATIONAL DVD SALES (IX) + INTERNATIONAL DVD RENTALS (X)

The home video distributor, which is normally a fully-owned subsidiary of the main info-entertainment conglomerate, is nowadays believed to retain at least 80 percent of the wholesaler’s gross revenue from the sale and rental of the DVD.[30] Furthermore, both datasets providing the imported variables on domestic DVD sales (i.e., The Numbers ) and on domestic DVD rentals (i.e., Box Office Mojo) are based on retail prices.[31] Therefore, variable VII. WHOLESALER’S GROSS HOME VIDEO REVENUE was calculated after removing a retail markup of 40 percent from the gross home video revenue, given that the distributor’s share of the gross rental revenue[32] and the “dealer price” (i.e., wholesale) of the units sold[33] should be approximately 60 percent of the market price.

• (IX.) INTERNATIONAL DVD SALES OF A MOTION PICTURE
• • = INTERNATIONAL BOX OFFICE*/DOMESTIC BOX OFFICE* × DOMESTIC DVD SALES*
• (X.) INTERNATIONAL DVD DVD RENTAL OF A MOTION PICTURE
• • = INTERNATIONAL BOX OFFICE*/DOMESTIC BOX OFFICE* × US DVD RENTAL GROSS*

Moreover, variable VIII. GROSS HOME VIDEO REVENUE OF A MOTION PICTURE was calculated by adding up the revenues from sales and rentals in the domestic and international markets. However, the data on international DVD rentals and sales was estimated because it is considered highly confidential by Hollywood distributors.[34] These estimates are calculated (respectively) from the variables US DVD RENTALS GROSS and DOMESTIC DVD SALES and adjusted in order to account for a difference in taste between the domestic and international audiences. This difference is integrated in the calculation by assuming that the ratio between the DVD sales (and rentals) in the international and domestic (i.e., US) markets of each motion picture in the sample is the same as the ratio between the international and the domestic box office revenues (see IX and X). This implies that, if the theatrical release of a movie was less (or more) successful abroad than in the domestic market, the same dynamic (and difference) also applied to the DVD.

• (XI.) REVENUE OF A MOTION PICTURE FROM TELEVISION (US & INTERNATIONAL)
• • = (PERCENT OF DOMESTIC GROSS BOX OFFICE OF A MOTION PICTURE IN 2007)
  • × (TOTAL GROSS REVENUE FROM TELEVISION IN 2007 OF ALL MOTION PICTURES*)

Notably, the gross revenue of a motion picture also includes the licenses paid by broadcasters to the distributor. Motion pictures are licensed domestically and internationally to pay television stations, network television stations, and then to (other) cable and terrestrial television stations (i.e., the “free” television stations). Moreover, although there are some guiding principles, the terms of licensing—which include the number of runs, the lengths of “blackout periods,” and the nature of the license itself—are negotiated for each movie with each broadcaster or group of affiliated broadcasters.[35] Often movies are licensed in a “bundle” with other films and/or television programs. Moreover, methods of pricing these licenses vary. Domestic cable television would normally be charged a fee equivalent to a percentage of the theatrical box office (e.g., 15 percent), up to a maximum of $25 million; other types of (seemingly less frequent) deals, however, might include an up-front fee and a share of the advertising revenue. Alternatively, the price charged to pay television is commonly calculated as a fixed dollar amount per subscriber.[36]

Given the diversity of licensing deals and the absence of reliable and detailed data, the methodology chosen to calculate the variable XI. REVENUE OF A MOTION PICTURE FROM TELEVISION (US & INTERNATIONAL) has to be necessarily simple: the relative success of a movie at the box office in the domestic market always provides the basis for negotiation between distributors and television broadcasters. Notably, a relatively large return from the box office entitles a distributor to ask for a relatively high price, regardless of how the licensing deal is fashioned.[37] Therefore, the decision was made to divide the total worldwide receipts from television windows in 2007 (i.e., $16.2 billion, according to the MPAA) by each motion picture’s share of revenue from the total domestic box office.[38] Notably, television revenue from movies released in 2007 was only partly realized in that year, accruing mainly in the years that followed. The 2007 data, however, are the most recent available, and one can assume that there are relatively small changes from one year to another as indicated by the revenue figures from 2006 and 2005.[39] Therefore, the calculations of this variable assume that the overall revenue from television licensing in 2007 derives from the slate of motion pictures released that same year. In other words, the revenue of motion pictures released in the past and traded in 2007 (which is included in the figure adopted for the estimate) is used as a proxy for the revenue that motion pictures released in 2007 would realize in the following years.

A Motion Picture’s Total Negative Cost

The total negative cost is the sum of all the expenses necessary to make a movie. This variable is calculated according to the following formula:

• (XII.) TOTAL NEGATIVE COST OF A MOTION PICTURE
• • = PRODUCTION COST (XIII) + INTEREST ON PRODUCTION COSTS (XIV)
  • + ADVERTISING OVERHEAD (XV) + ADMINISTRATIVE FEES (XVI)
  • + DISTRIBUTION FEES (XVII − XIX)
• (XIII.) PRODUCTION COST OF A MOTION PICTURE
• • = 80% OF THE PRODUCTION BUDGET*

Variable XIII PRODUCTION COST OF A MOTION PICTURE was calculated as a percentage (80 percent) of the “declared” production budget, which was made available to the press by distributors and producers. In most cases, the real negative cost is likely to be smaller than the declared budget, as the latter may include administrative charges and interest (which here are calculated separately), or, more generally, because distributors and producers often inflate the budget figures leaked to the press (and collected by the databases that are the sources of data of this study) as a marketing strategy that signals to the public the “superior quality” of their films. For example, Epstein notes that the Warner Bros. movie The Negotiator (1998), with Samuel L. Jackson and Kevin Spacey, was efficiently produced for $43.5 million, as opposed to the $50 million budget figure that was made publicly available.[40] Sometimes, when the cost may be perceived as too high for the type of movie or when a movie performs particularly poorly at the box office, the data on the production budget and/or the negative cost remains secret. More rarely, the budget figures communicated to the press are underestimations of the real negative costs.[41] This may have been the case, for example, with the film Evan Almighty (2007), distributed by Universal Pictures and considered one of the biggest “Hollywood bombs” of the year. According to The Numbers and Box Office Mojo, Evan Almighty’s budget was $175 million, while the Los Angeles Times reported a negative cost of over $225 million.[42]

• (XIV.) INTEREST ON THE PRODUCTION COSTS OF A MOTION PICTURE
• • = 10% OF THE PRODUCTION COST (XIII)

As both Ulin and Wasko indicate, distributors charge interest on the cost of production. The interest rate chosen here is the same that Ulin uses in his example, 10 percent,[43] although Wasko states that this could be between 12 and 25 percent.[44]

• (XV.) ADVERTISING OVERHEAD OF A MOTION PICTURE
• • = 10% OF THE PRODUCTION COST (XIII)

Although some stakeholders involved seemingly find this unfair, as they consider advertising a distribution task that should be included in a distributor’s fee, a fixed percentage provision (commonly 10 percent) is normally added to the movie’s negative costs.[45]

• (XVI.) ADMINISTRATIVE FEES OF A MOTION PICTURE
• • = 15% OF THE PRODUCTION COST (XIII)

Moreover, as both Ulin and Wasko explain, a charge of 12 to 25 percent of the production cost is normally added and included in the total of the negative cost in order to cover the studio’s expenses.[46] Here, following the most recent source, this charge is assumed to be 15 percent.[47]

• ((XVII.) DISTRIBUTION FEES, THEATRICAL
• • = 35% OF FILM RENTAL (US & INTERNATIONAL) (V)
• (XVIII.) DISTRIBUTION FEES, TELEVISION
• • = 35% OF TV REVENUE (US & INTERNATIONAL) (IX)
• (XIX.) DISTRIBUTION FEES, HOME VIDEO
• • = 35% OF HOME VIDEO REVENUE OF A MOTION PICTURE (US & INTERNATIONAL) (VI)

In addition to interest, advertising costs, and administrative fees, distributors charge a fee for selling the movie and managing its licenses. This fee is assumed to be 35 percent and is applied to the film rentals, the consolidated revenue from television, and the revenue from home entertainment (all both domestic and international). To simplify, the fee percentage utilized by this study is an average of the rates suggested by Ulin and by Wasko.[48]

The Conglomerates’ Profits from Motion Pictures

A conglomerate’s profits from a motion picture are calculated as adding the profits (or losses) from a movie with the profits realized by the main distributor and the profits generated from home distribution. Following the most likely case scenario and for the sake of simplicity, all of the motion pictures in this sample are assumed to be coproduced by different stakeholders. Therefore, in the calculation of the conglomerate’s profits from a movie, only 50 percent of the latter are included; nonetheless, the conglomerate is assumed to bear 100 percent of the losses when these occur.[49]

Tentpole movies based on franchises as well as some less expensive movies are likely to generate other important revenues in ancillary markets. These include theme-park royalties, music and book royalties, and royalties from derivative works or the underlying material.[50] The revenues from these markets are normally not included in the calculation of a movie’s profits or losses even though they are earned by the conglomerate that owns the intellectual property associated with the film.[51]

• ((XX.) PROFITS (OR LOSSES) FROM A MOTION PICTURE (CONGLOMERATE)
• • = 50% OF PROFIT (OR 100% OF LOSS) FROM A MOVIE (III)
  • + PROFIT (OR LOSS) FROM DISTRIBUTION (XXI)
  • + PROFIT (OR LOSS) FROM HOME VIDEO DISTRIBUTION (XXIV)
• (XXI.) PROFITS (OR LOSSES) FROM DISTRIBUTION
• • = DISTRIBUTION FEES FROM THEATRICAL (XVII)
  • + DISTRIBUTION FEES FROM TELEVISION (XVIII) − TOTAL COST OF PRINTS (XXII)
  • − DISTRIBUTOR’S OVERHEAD (XXIII)

Given that advertising expenses are paid from the movie’s returns,[52] the calculation assumes that fees paid to the distributor are used to pay for all the expenses necessary to run the distributor’s operations (i.e., the distributor’s overhead) and for the movie’s prints. Because distributor’s fees affect the cost of the movie, the methodology of how these were estimated was already detailed above; estimates of the distributor’s overhead and the total costs of prints are introduced below.

• (XXII.) TOTAL COSTS OF PRINTS PER MOTION PICTURE
• • = 2 × 1.07 × 1344 × WIDEST RELEASE*

The estimate for the variable TOTAL COSTS OF PRINTS PER MOTION PICTURE was informed by Ulin’s estimate that the average cost of a print is $1,500[53] and the average cost of a digital print is approximately $200.[54] Ulin assumes that a movie is shown on average on two screens per location and that prints are “bicycled” to secondary and international venues, given their high cost. [55] Ulin also assumes that backup copies for important venues are printed and distributed; these backup copies account for an additional five hundred copies in the case of a distribution to seven thousand screens (so, about 7 percent). He estimates that the printing cost of movies such as Shrek 2 and Spiderman 2 is no less than $11.25 million for the US market alone.[56]

Moreover, in a 2012 report, the MPAA estimated that in 2007 in the US 34,342 screens were analogue, 986 were digital 3-D, and 3,646 were digital non 3-D screens.[57] That means that 88 percent of screens required prints and 12 percent digital copies. Therefore, the estimates of the costs of prints per movie are calculated as follows: the cost of prints is proportional to the number of theaters of the variable WIDEST RELEASE found on Box Office Mojo. The number of prints is then multiplied by 2 in order to estimate the number of screens and by 1.07 to account for backup copies. The average cost of one print also accounts for 12 percent of digital copies; therefore, it is estimated at $1,344 (1500 × 0.88 + 200 × 0.12). The calculation assumes that all wide-release copies are then bicycled.

• (XXIII.) DISTRIBUTOR’S OVERHEAD
• • = 8% OF PRODUCTION COST (XIII)

The variable XXIII DISTRIBUTOR’S OVERHEAD is estimated at 8 percent of the production cost. According to Epstein, this is the actual cost of distributing the movie, which includes fees paid to “public relations specialists, media buyers, as well as expenses for customs clearance, transportation and lawyers’ time.”[58]

• (XXIV.) PROFITS (OR LOSSES) FROM HOME VIDEO DISTRIBUTION
• • = 80% OF THE WHOLESALER’S GROSS HOME VIDEO REVENUE (VII)
  • + DISTRIBUTION FEE, HOME VIDEO (XIX)
  • − COSTS OF HOME DISTRIBUTION (27% OF THE WHOLESALER’S GROSS HOME VIDEO REVENUE)

The variable XXIV PROFITS (OR LOSSES) FROM HOME VIDEO DISTRIBUTION consists of 80 percent of the wholesaler’s gross home video revenue, plus 35 percent of the share of the movie’s revenue from the home video sales and rentals, which are paid out as the home distribution fee (therefore, effectively 87 percent of the dealer’s gross). The home video distributor, however, has to bear the costs of printing, promoting, and distributing the DVD. In 2007, the cost of printing, promoting, and distributing a DVD was about $6.75, roughly 27 percent of the retailer price of the time (about $25).[59] Therefore, the cost of printing, distribution, and promotion (borne by the home video distributor) was estimated as 27 percent of the gross home video revenue and the studio’s home video revenue calculated as the difference between the wholesaler’s gross home video revenue and this cost of production.

Motion Pictures’ Rate of Return and the Share of Movies Making Profits

Estimates of each motion picture’s rate of return (RoR) are calculated from the computed variables “net profits (or losses) of motion pictures”—the surplus (or loss) realized from the viewpoint of the production, and from the profits (or losses) realized from the viewpoint of the conglomerate. These variables are useful to illustrate the total rate of commercial success of the 2007 slate of movies and to compare the rate of success of each distributor and conglomerate. Given that many assumptions had to be made in order to calculate the missing variables and observations required to perform these calculations, a rate of return showing a small profit margin or a contained loss can be too highly dependent on methodological choices. On the contrary, a rather large profit or loss according to estimates calculated clearly has a higher probability of corresponding to a real profit or loss.

Therefore, in order to increase the consistency of the results obtained, the “success rates” of variables are defined by an interval, which is determined by two definitions: the first definition takes into account all the movies, while the second definition only takes into account the motion pictures that generated a rate of return of 30 percent or higher, and the motion pictures generated a rate of return of −30 percent or lower.

To summarize, the rates of return and consequent success rates are calculated according to the following formulae:

• (XXV.) RATE OF RETURN (PRODUCER) ON A MOTION PICTURE
• • = NET PROFITS (OR LOSSES) FROM A MOTION PICTURE (III)
  •  / MOTION PICTURE’S TOTAL NEGATIVE COST (XII)
• (XXVI.) RATE OF RETURN (CONGLOMERATE) ON A MOTION PICTURE
• • = NET PROFITS (OR LOSSES) FROM A MOTION PICTURE (CONGLOMERATE) (XX)
  •  / TOTAL NEGATIVE COST (CONGLOMERATE) (XXVII)
• (XXVII.) TOTAL NEGATIVE COST (CONGLOMERATE) OF A MOTION PICTURE
• • = PRODUCTION COST (XIII) + ADMINISTRATIVE FEES (XVI)
  • + INTEREST ON PRODUCTION COSTS (XIV) + ADVERTISING OVERHEAD (XV)
  • + DISTRIBUTOR’S OVERHEAD (XIII) + TOTAL COST OF PRINTS (XXII)
  • + WHOLESALER’S GROSS HOME VIDEO REVENUE (VII)
• (XXVIII.) RATE OF SUCCESS (PRODUCER)
• • = [MIN, MAX] OF [% OF MOTION PICTURES WITH A POSITIVE ROR (PRODUCER), % OF MOTION PICTURES WITH A POSITIVE ROR (PRODUCER) WHEN CONSIDERING ONLY THE MOVIES WITH ± 30% ROR]
• (XXIX.) RATE OF SUCCESS (CONGLOMERATE)
• • = [MIN, MAX] OF [% OF MOTION PICTURES WITH A POSITIVE ROR (CONGLOMERATE), % OF MOTION PICTURES WITH A POSITIVE ROR (CONGLOMERATE) WHEN CONSIDERING ONLY THE MOVIES WITH ± 30% ROR]

Note: Calculations explained in the text of the article. Note that Min. sample indicates the percent share of sample considered when only the motion pictures producing at least a return on investment of + (resp. − ) 30 percent are successful (resp. unsuccessful); N is the number of movies that generate a positive return.