Will digital distribution be the savior of the independent film market? Steve Zeitchik sets out to explore this question, using indie producer Seth Caplan as a case study.  Caplan has produced numerous award-winning, festival screened features, but his only real financial success barely left the internet. “Flatland – The Movie,” a thirty minute animated featurette sold mainly via web streams, generated more profit than any of his other films due principally to a well-placed Google Ad.

With the advent of YouTube, distribution was democratized to the average Joe, but now its success is “trickling up.” Industry professionals, the big fish and the small, are increasingly taking advantage of all-access digital mediums.  But it’s those with limited resources, the indie players, who stand to gain the most. Where else but online could they reach so many people at so little cost?

Of course, this supposed Promised Land comes with a catch or two.  Many fear that, like in the digital music space, an “increased dependence on digital will mean similarly small profits and expectations.”  This has been the case so far for most films released digitally. However, theatrical avenues are drying up, and films are coming out of festivals without theatrical distribution, leaving filmmakers little choice but to turn to online.

Still, there are promising signs for those that take a strategic approach to digital. Major portals, including Amazon, Hulu, iTunes, and YouTube, now have their own indie businesses. Though the sites have yet to garner much revenue for filmmakers, they can cut out the middle-man, like they did for Seth Caplan. IndiePix president Bob Alexander elaborates:

“The problem with streaming is you need millions of views for what’s essentially a niche product…what streaming can do, however, is provide the visibility and platform to lead to transaction-based sales [i.e., dvd’s].”

[Disclaimer: Filmmakers Beware! To turn a profit this way, you can’t let your budget get away from you.  It’s more essential than ever to contain costs when margins are so low.]

As the way we consume media continues to evolve, streams and other online viewing have the potential to capture greater market share, so early adopters are well-positioned to benefit. But for now, caution is advised.

*Source: The Hollywood Reporter, “Clicking and Screaming”, pp 10-11, March 20, 2009, by Steven Zeitchik

To read the entire article, click here. (available only in plain text for non-subscribers)

Readers of the Film Funding Blog often ask, “are studios and distributors spending marketing money wildly?” This really speaks to an underlying question, is theatrical distribution unprofitable for independent films?

To address this issue, I thought it might be helpful for me to contribute some perspective on the forces that can shape the P&A budget. My analysis is based on my years as a film distribution executive at Fox, Warner Bros., and New Line Cinema. I mention my background so that you can judge circumstances for yourself, without any undue spin.

(Photo by atp_tyreseus)

When a national theater chain decides to buy a picture, we usually consider that to be a good thing. But, one of two things may happen. First possibility is that the picture opens wide. This means that P&A is needed to support a large release (more prints, local newspapers, radio/TV, etc) and, before a single ticket is purchased, potentially millions of marketing dollars have been spent. If the film does not open well, the marketing spend will look hugely out of proportion to the results. Unfortunately, the final outcome is only knowable after most of the money has been spent.

Alternatively, it is possible to “platform” a film release. However, this usually works best in cases where you think the word of mouth will be very strong. Problem with a platform release is that you may never get a chance to open wider. Your theatrical distribution costs are lower, and your theatrical release may be profitable on a percentage basis, but you could wind up leaving millions in profit on the table.

Given the chance to open on say 500 screens (still far from a mega release), and a platform (2-20 screens), most people will choose to open wider because the revenue and profit tend to be higher (higher risk/higher return). Also, if a theater chain offers a wider release, if you suggest a smaller one you may be signaling a lack of faith in the motion picture.

Usually, as a producer/financier, you have almost no control over how the picture rolls out. Even if you pay the P&A cost, you are at the whims of the marketplace (actually, you are just facing more powerful players with stronger leverage). This means that your distribution strategy faces a complex set of dynamics, and you are forced to play the hand you are dealt.

As a footnote, the advertising for domestic releases is also tracked by the video retailers. They know that if the film did not have much market support, there is unlikely to be much awareness. This can limit the DVD sales.

There can be more upward pressure on a film’s marketing spend. Other ancillary markets (like airline sales) are frequently pegged to the US Box Office. It can often pay to buy a larger box office opening by spending more on theatrical marketing. Theatrical will run at a loss, but the goal is to build profit from DVD, television, and other distribution channels.

I would say that the typical film does not break even from theatrical. Even the most successful independent releases make only a very small profit from theaters. Could the marketing money be better spent? There is always the old adage that half the marketing budget fails to produce the desired result. It just isn’t that easy to figure out which half. Theatrical is not always a money loser, but it does tend to be a loss-leader.

Pirates (not the Caribbean ones) are sending shockwaves through the motion picture industry. Hacker sites are reporting cracking the encryption on both formats of high definition DVD. This is a tremendously negative development for consumers. Already skittish about making high definition programming available due to piracy concerns, this news confirms the entertainment industry’s worst fears. I think we can look forward to even more stringent digital rights management (DRM) that limits available content and decreases consumer enjoyment of the latest movies and entertainment programming.

Here is a summary of the hack:

HD DVD and Blu-ray Now Completely Hacked, Cracked, Sacked

Gizmodo , February 13, 2007 Tuesday 11:15 AM EST

Feb. 13, 2007 ( delivered by Newstex) –

The guys at the Doom 9 forum are marking February 11, 2007 as the day when digital rights management was defeated on Blu-ray and HD DVD discs. It turns out that cracking the high definition disc formats was much easier than was originally thought. The processing key that can unravel the DRM on all HD DVD and Blu-ray discs has been found by a clever encryption fighter named arnezami.

It gets better:

The first-reported and Blu-ray discs were not completely effective, because each individual title had secret codes that were needed to unravel the rest of the encryption on that disc. But now this newly-found processing key is apparently the holy grail that unlocks the DRM on all HD DVD and Blu-ray discs released so far. The guy found it by simply watching his computer memory, where the secret code–which we won’t publish here for fear of doing jail time–simply appeared. Incredible. Let the free downloads begin! — Charlie White

[Doom9 Forum]

http://www.contentagenda.com/articleXml/LN570885857.html?industryid=45180

You can also check out this post on Boing Boing:
http://www.boingboing.net/2007/02/13/bluray_and_hddvd_bro.html

What was the most profitable film release of 2006? It all depends on how you measure profit.

As the blog BizofShowbiz reports:

In the category of the most widely released movies for 2006, the most profitable movie of the year was surprisingly “Ice Age: The Meltdown,” which beat out what most thought would be the leader “Pirates of the Caribbean: Dead Man’s Chest.”

http://www.bizofshowbiz.com/2007/01/ice_age_most_profitable_film_of_2006.html

This is based on the 2006 Kagan Profitability Report that the Holllywood Reporter’s Paul Bond discusses in his recent article. http://news.yahoo.com/s/nm/20070119/media_nm/profits_dc_1

While Kagan does a great job with their profitability index, they exclude several key elements of production cost (because they are extremely difficult to estimate.) Distribution fees, profit participations (points), overhead allocations, and the cost of financing (interest charges) do not make it into Kagan’s calculations.

Based on the gross profit percentage, it is likely that Little Miss Sunshine would take the crown. However, if we look at total profit in dollar terms, I have no doubt that Pirates of the Caribbean: Dead Man’s Chest would be ranked first. With 15.1 million units of DVD sold and box office of over $400 million in the U.S. alone, the revenues were tremendous. While the participations and residuals were no doubt costly, the profitability of DVD would propel this title ahead of the others.

The truly interesting question is to look at the profitability of a film like this from different perspectives. The profit picture for the studio (Walt Disney Company: DIS), is very different from that of the other profit participants (such as the key talent or the film’s producers.) One difference is that Disney earns a distribution fee and receives the overhead allocations, adding revenues to its coffers. On the other side of the ledger, these items are costs to the profit participants.

“Notwithstanding last year’s disparaging headlines regarding declining box office and DVD sales, 2006 ticket sales and DVD purchases proved that the public actively enjoys movie-going and the in-home DVD experience, despite the proliferation of other entertainment alternatives,” Genius Products CEO Trevor Drinkwater said.

Much of the cheery-eyed optimism floating around the studio DVD divisions stems from the fact that the industry has just come off an exceptionally strong fourth quarter. Things got off to a good start when 20th Century Fox’s X-Men: The Last Stand and Buena Vista’s The Little Mermaid Platinum Edition generated $80 million in consumer spending in a single day. Further triumphs came as the quarter progressed, culminating this month when Buena Vista’sPirates of the Caribbean: Dead Man’s Chest sold 10.5 million DVDs its first week in stores, putting it on track to become the top-selling live-action DVD ever.

“A couple of interesting things happened in the fourth quarter,” Warner Home Video president Ron Sanders said. “You had some very strong theatricals that performed very well across the board, and you also had the additional benefit of TV-DVD continuing to have a huge upside, year-over-year. All of this pointed to a very healthy category.”

Visit BrandWeek for more information:

http://www.brandweek.com/bw/news/sportsent/article_display.jsp?vnu_content_id=1003525962

I was flamed in the pages of Going Private, a memoir blog chronicling the insights of a private equity professional. Nothing better to do? Read the latest musings here. Short on time? This sort of sums it up:

But, then again, they don’t seem to know the difference between revenue and net income (in my not entirely limited experience a very common problem in Hollywood).

And then there is:

I’m not sure they understand the structure of film production financing, or the nature and purpose of the many preferences that plague such financings. Clearly, the ramifications of changes in these structures in the Cruise case and way they give Cruise a major pay and status cut are lost on the authors. This is a pity, since they purport to be experts on the subject.

Ouch!

Making my job as a hard working Film Funding Blog author rather easy, Going Private provides the data to refute their own argument:

Budget estimates on the film vary, but range between $150 - $220 million in production, marketing and development costs.

I actually think the total costs are much higher than this, but let’s use that range for discussion. The share of box office flowing to the studio from domestic theatrical distribution on a film like MI3 is likely to be approximately 50%.

As an aside, initial exhibition terms probably started out more favorable to the studio, but the contract was likely revised downward. I agree that expectations for MI3 were not met (but maintain that the film will likely still turn a profit.)

Distributor share of box office on international distribution will probably come in closer to 48%, a little lower than U.S. share due to greater “off the top” deductions for box office taxes and theater checking (ticket audits).

Based purely on worldwide theatrical, studio revenue (their share of the box office) would be approximately $225M ($133.5 x 50% plus $330 x .48%). Pretty good for a “flop!” It is rare that a tentpole release breaks even on theatrical distribution. While I think costs are more than $225, coming this close, prior to ancillary releases, is actually a very positive indicator. That means the film will carry over a negative balance, but there are ample opportunities to recoup this shortfall in home video, television, and all other ancillaries.

Low and behold, MI3 is racking up huge sales with its DVD release. The Hollywood Reporter, well, reports:

Studio sources peg first-week sales at 3.7 million units, more than either of the two previous releases in the franchise. And that’s not counting an additional 20,000 units sold on the two next-generation formats, HD DVD and Blu-ray Disc — making “M:I 3″ the biggest-selling next-gen title since HD DVD’s April launch.

http://tinyurl.com/ymbqhr

My revenue estimate for DVD is $144M to $180M with a net of $116M to $145M. In an arcane twist, the studios can capture up to 75% of these DVD revenues without sharing the proceeds with talent, the film’s producers, or other net profit participants.

Even so, with only 25% of the DVD revenues (referred to as a royalty, the base used for revenue calculations in participation agreements) MI3 will still start to cross over into positive territory. DVD sales, TV, and other downstream distribution will trigger contractual residual payments to the writers, actors, and the director. However, I’m fairly confident that DVD revenues and income from the super-secret television output deals will easily cover those costs.

The bottom line? The studio will be fully reimbursed for all costs and stands to earn a distribution fee of 12-15% of total revenues, plus the 75% of DVD (minus replication and marketing). This is very conservatively north of $100M in profit to the studio. Final figures could easily be double this when all distribution channels are considered.

For profit participants, they may see somewhere over $50M depending on distribution, marketing, and overhead costs allocated to the picture. For Tom, he’ll make more money from his points on the film than from his $20M salary.

On a closing note, the latest rounds of hedge fund deals in Hollywood have done away with the stacked deck. Fund investors participate on equal footing with the studios, the portfolio of films include (many of) the crown jewels, and the revenue and cost estimates are fully vetted. (For example, fund investors share in the full pot of DVD revenues.) Come on Going Private, cut us a break! We may not be the sharpest tools in the drawer, but give us credit for at least being able to add and subtract (with an occasional ability to multiply and divide.) Could it be that maybe this time, you’re just wrong? Perish the thought.

The basic issue on DVD sales, Greenfield reports, is that there has been a decline in catalog sales, as the �halo effect� from an expanding DVD consumer base is over. In short, almost everyone now has a DVD player, and they�ve replaced their VHS catalog titles - so now the market will be driven largely by the ability of the studios to produce hits.

http://biz.yahoo.com/seekingalpha/061008/18035_id.html?.v=1

Growth in the DVD marketplace is definitely slowing. However, this is really not a surprise to anyone. The major studios and other distributors forecasted a leveling off of the business several years ago. They thought that a High-Definition format would offer an even better home entertainment experience, and fuel new growth for the industry. The forwat war that has ensued has been a serious obstacle to the industry.

The DVD slowdown has profound, and negative, implications for independent films. Currently, theatrical distribution is often a losing proposition for indie films. The marketing costs to launch a film are expensive and very hard to recoup. However, the theatrical release sets up a film for greater success in other distribution channels. Profits can be obtained from DVD, television/cable, and other ancillary markets.

With deterioration in DVD sales, retailers will start to decrease the shelf space that they devote to movies. The retailers have to maximize the sales per square foot of selling space.� If DVD is not selling, they will shrink those departments and give that space over to other products. This means fewer titles purchased by the retailer, worsening the odds for independent films.

Retailers will try to increase their profit from DVD by negotiating for lower wholesale costs with the distributors.� Faced with the choice of losing shelf space (and the significantly reduced opportunity to sell DVD), or lowering wholesale prices (improving profit for the retailer at the expense of the distributor), distributors will opt for lowering cost/improving retail margin.� This means less revenue flowing to the distributor. As virtually all distribution deals for indie films have a revenue sharing component, this ultimately means less money flowing to independent producers.

20th Century Fox has unveiled a new division � FoxFaith � created to acquire and distribute “morally-driven, family friendly programming,” according to its Web site, which explains, “to be part of FoxFaith, a movie has to have overt Christian content or be derived from the work of a Christian author” http://abcnews.go.com/Entertainment/story?id=2472082&page=1

Film distributors have always distributed speciality titles. This effort is indicative of the next wave of niche marketing in the film business. Be sure to visit the FoxFaith website. They are also establishing a club/loyalty program as part of the marketing plan.