Hollywood's death spiral, part 2.

The numbers behind the industry.
Aug. 1 2005 9:13 AM

Hollywood's Death Spiral, Part 2

Are movie theaters facing extinction?

Click here to read Part I of Hollywood's Death Spiral.

Illustration by Mark Alan Stamaty.
Click image to expand.

The $64 billion question in Hollywood these days is what to do about collapsing the boundary between a movie's theatrical and video release—the so-called video window. Gradually, this window has shrunk from six months to four months—and, in the case of many children's movies—to three months. Even worse, DVD releases are often announced while a movie is still playing in the multiplexes. As a result, more moviegoers now wait to buy or rent a movie on DVD, which leads to shorter theatrical runs and a fall in worldwide theater attendance, which in turn puts more pressure on the studios to shorten the window even further.

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This death spiral was set in motion by the studios themselves about four years ago. The decision to shorten the video window did not proceed from a new technological development—such as TV in the 1940s or the video cassette in the 1970s—or a change in popular taste. As a top studio executive explained to me, "It was a voluntary decision made for purely financial reasons by the major players. It was done to satisfy quarterly profit goals, nothing more, nothing less." In short, the studios changed their business model so that they could opportunistically sell DVDs, which, after all, are a conventional retail product like soap or toys.

The continuing pressure to further shorten the video window comes, not surprisingly, from the Young Turks in the lucrative home-entertainment divisions of the studios. In the first quarter of 2005, these divisions were producing more than two-thirds of the revenues for the six studios. Their main battleground is the shelf space of Wal-Mart and other giant retailers, and, to prevail—and further increase quarterly earnings—the home-entertainment divisions need to release DVDs during the hottest sales periods, such as Christmas and Thanksgiving, instead of waiting for an artificial window to open.

The main resistance to this change comes from the old-guard studio executives who fear that undercutting the movie-theater business will—even if it improves DVD sales—unravel the very foundations of Hollywood. They argue that the theatrical platform, to which the PR hoopla, magazine covers, TV talk shows, and the rest of the celebrity-worshiping culture is geared, transforms movies into media events that generate worldwide DVD sales. For them, the issue is how to keep the theatrical platform alive.

The most radical proposal is to eliminate the windowing system entirely. In this scenario, the studios would simultaneously release a title in theaters, video stores, and on pay-per-view, and the title would require only a single marketing campaign. The audience could then choose which format best fits its wallet and clock. Proponents of this plan envision that it will shift some part of the theater audience to either DVD (which has higher profit margins than theatrical distribution) or pay-per-view (which has higher profit margins than DVD). Even so, they hold that movie theaters will retain a core audience, since there will always be people who prefer the theater experience or who just want to get out of the house.

The hitch here is that the popcorn economies of the multiplexes are extremely fragile. "We are in the people-moving business," a multiplex owner explains, "We make our real money moving customers to the popcorn stand." Since movie theaters have fixed costs, such as leases and interest payments, a relatively small dip in the traffic to the popcorn counters could make it impossible for them to remain open. Just a 6 percent drop in attendance in 2000-2001, for example, put most of the theater chains into bankruptcy.

A second proposed solution is the "Godfather" scenario. Studios would offer the multiplexes a deal they can't refuse: In return for keeping the video window intact, multiplexes would "incentivize" studios by forking over an additional share of the box-office earnings. Presently, theaters keep about 50 percent of the box office. In this scenario, the multiplex chains would keep only 45 percent and get a guaranteed five-month video window (or 40 percent and get six months). Theaters would have a stabilized attendance and a steady line at the popcorn counter, and the studios would get more money to compensate them for the lost DVD sales. In 2004, for example, the five-month window charge would have yielded studios three-quarters of a billion dollars.

The obvious problem with this ingenious offer is that the studios are not the Godfather. They cannot act in concert because of the antitrust laws, and there are severe penalties for price fixing. An individual studio would have to make an offer to the huge national chains—such as Regal Entertainment and AMC/Loews—that own most of the screens in America. These chains would be loath to transfer a large part of their profits to the studio since, even with the video window intact, attendance may continue to fall. Instead, they might deliver a counter-ultimatum: Unless the studio preserves the video window, the chain will not book any of its films. No studio could afford to lose the screens at these chains, making the Godfather scenario a non-starter.

The third possible solution is a compromise: a split-window scenario in which different movies would have different paths to DVD. This strategy involves a triage via test-screenings, polls, and focus groups to distinguish between the movies that will find traction with audiences and those that are less promising. The movies with "playability" would retain a minimum five-month window. These movies would presumably have a favorable word-of-mouth that would draw audiences and help keep the movie theaters in business. Meanwhile, the triaged movies would be quickly released on DVD after token theatrical engagements or go directly to DVD. The fast-tracking of these DVDs would provide a slew of titles for retailers' shelves at opportune times. Window-splitting may sound like an appealing compromise, but, in the view of old-guard executives, it would turn out to be nothing more than a way station en route to collapsing the window entirely. Once some titles are released early on DVD, the pressure from Wal-Mart to release others would prove irresistible.

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