Hollywood Creative Accounting: The Success Rate of Major Motion Pictures

The business of filmmaking in Hollywood radically changed following the controversial release of Michael Cimino’s Heaven’s Gate (1980), whose financial losses so weakened its producer-distributor United Artists that it was soon after taken over by Metro-Goldwyn-Mayer (MGM).[3] As a distributor, United Artists embodied an approach to filmmaking that had become “emblematic of the art in the 1970s, based on prizing the independence of directors and glorifying artistic innovation.”[4] Therefore, the demise of United Artists led the way to an alternative approach to filmmaking, one more focused on commercial goals. Distributors belonging to the largest info-entertainment conglomerates (here, “the major distributors” or “majors”) shaped the principles of the new business strategy, which involved large investments in films designed to generate important revenues from emerging and rapidly growing secondary markets, including retail video sales and rentals, pay-per-view cable channels, and digital downloads.[5] In more recent years, the exploitation of intellectual property (e.g., characters, images, and scores) in ancillary markets (e.g., books, music CDs and digital downloads, video games, theme parks, fast food restaurants and various other merchandising items) also became an important element of this strategy.[6] As a result, distribution became the “art of maximizing consumption and corresponding revenues across exploitation options,"[7] and film distributors took on more and more important roles within the increasingly vertically integrated value chains of media conglomerates.[8]

Although the strategy of the majors has been changing quite radically since the 1980s, analyses of the profitability or the success rates of motion pictures produced by these companies seems to be largely lacking. On the contrary, the existing body of literature describes the film business as characterized by regular commercial failures and a few very fortunate successes. For example, in 1998, Weinstein bemoaned that only 10 to 20 percent of film projects were reporting net profits.[9] In 2008, the United Nations echoed these estimates, saying “it was widely recognized” that only 20 percent of movies made a profit.[10] In making these assertions the aforementioned articles failed to cite any empirical studies, but in 2004 De Vany and Walls confirmed these estimates after studying a large sample of films released between 1984 and 1996. They concluded that about 78 percent of these movies lost money and only 22 percent were profitable.[11]

Many scholars of media policy and economics are likely to have encountered other variations of this “20 percent success rule” in reports and academic papers implying that the generic producer or distributor—large corporations and small independent companies alike—can survive or build fortunes thanks to the success of a few lucky projects. However, Hollywood accounting is known to be creative,[12] employing contractually defined notions of net profit[13] that can be very different from the generally accepted accounting principles applied in other sectors.[14] As explained in this article, although the definition of net profits can vary from distributor to distributor (and from contract to contract), all of the existing versions seem to share a common rationale: the most significant degree of bargaining power generates a surplus for the most significant stakeholders, even when a motion picture officially does not make a net profit.

Therefore, a more careful examination of the notion of profit used in the formulation of the 20 percent success rule is important for understanding what this commonly-accepted statement actually reveals about the financial risk of filmmaking. De Vany and Walls define the net profit of a motion picture in admittedly simple terms: as the difference between the film rentals (i.e., the share of theatrical ticket sales that is fed back to the distributor) from the United States and Canadian markets minus the production costs of the movie.[15] Therefore, the 20 percent success rule seems to suggest that only (about) one in five motion pictures earned enough from the first exhibition window to cover the costs of production. Furthermore, among this small percentage of motion pictures, there is a small collection of very fortunate projects that generate incomes much larger than their costs. What the 20 percent success rule does not explain is how many motion pictures released generate a positive return after having exploited all the opportunities available and how that income is distributed between the stakeholders.

In addition to theatrical release in the US and Canada, Hollywood motion picture revenue also includes film rentals from theatrical release in international markets as well as income from secondary and ancillary windows. Moreover, the distributors that commonly produce or coproduce a motion picture also manage the film’s exploitation in the first and subsequent windows. They normally take most of the risks associated with the production and release of a motion picture, and hence are the stakeholders claiming the largest share of its revenue. Furthermore, the distributors that are part of the six major info-entertainment conglomerates directly control the exploitation of motion pictures in different windows through a network of fully-owned subsidiaries (e.g., Comcast, NewsCorp, Disney, Viacom, Time Warner, and Sony Corp.). The income generated by a motion picture in secondary and ancillary markets is nowadays so important (up to 80 percent) that the primary activity of the major distributors is to manage intellectual properties to create synergies between the different windows of exploitation.[16] Therefore, the high level of uncertainty that once characterized the return from the theatrical release does not affect the choice of content or, more generally, the business strategy of the major distributors as it did before the expansion of secondary and ancillary markets.

This study attempts to critically review the 20 percent success rule and to question the commonly accepted belief that the business strategy of the media conglomerates is highly influenced by the volatile market conditions that may characterize the theatrical release. In order to reach this objective, it calculates the success rate of a slate of motion pictures distributed in 2007 by the majors and their subsidiaries. These success rates take into account revenue estimates realized in (most of) the secondary windows and are calculated from the viewpoint of the producers and conglomerates.

The year 2007 was chosen because it is the most recent annual span for which data concerning secondary markets revenue was publicly released.[17] In order to reach its objectives, this article draws from specialized websites[18] and from information (such as distributors’ fees and cost of prints) documented by a variety of experts about the most common practices employed by key stakeholders of the motion picture industry.[19]