Hollywood's profits, demystified.

The numbers behind the industry.
Aug. 8 2005 6:13 AM

Hollywood's Profits, Demystified

The real El Dorado is TV.

Illustration by Mark Alan Stamaty.
Click image to enlarge.

Multiple-Choice Quiz

Is Hollywood's biggest money-maker:
a) Movies?
b) DVDs?
c) Television?

The best-kept secret in Hollywood, especially from Wall Street, is that the movie studios' biggest profit center is not theatrical movies, or even DVD sales; it is TV licensing. If the details of the profits remain clouded to outsiders, it is no accident. The studios purposely blur together their three principal revenue sources—the box office, video sales, and television licensing—into a single portmanteau category called "studio entertainment" in their quarterly and annual reports. Keeping audiences in the dark may be a time-honored Hollywood tradition, but this breakdown can be demystified by consulting the studios' internal numbers, which they furnish to the Motion Picture Association on a confidential basis.

Last year, the six major studios—Disney, Fox, Warner Bros., Paramount, Universal, Sony, and their subsidiaries—had total revenues of $7.4 billion from world box-office sales, $20.9 billion from world video sales, and $17.7 billion from world television licensing. Revenues, however, are what companies record, not what they earn. And, in the case of Hollywood, the revenues from movies, DVDs, and TV yield very different earnings.

Once upon a time—before the TV and VCR—studios earned virtually all their profits from a single source: the theater's box office. Nowadays, in the new Hollywood, the world box office is a money loser: In 2004, the studios lost an estimated $2.22 billion on the $7.4 billion they took in from the box office. (Click here to see a table of this data.) This sad reality is not a result of the high cost of making movies, inefficiencies, or of any sort of studio accounting legerdemain. The simple fact is that the studios pay more to alert potential audiences via advertising and to get movie prints into theaters than they get back from those who buy tickets. Consider, for example, Warner Bros.' movie The Negotiator, with Samuel L. Jackson and Kevin Spacey. It was efficiently produced for $43.5 million, scored a world box office of $88 million, and appeared to be a modest success. In fact, Warner Bros. collected only $36.74 million from its theatrical release after it had paid check-conversion and other collection costs, the theaters had taken their cut, and the MPA had deducted its fee. Meanwhile, to corral that audience, Warner Bros.' advertising bill was $40.28 million, and its bill for prints, trailers, dubbing, customs, and shipping was another $12.32 million. So, after the movie finished its theater run, without even considering the cost of making the movie, Warner Bros. had lost $13 million. Why? For every dollar Warner Bros. got back from the box office, it shelled out about $1.40 in expenses, which was about average, if not slightly above par, for studio movies.

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This might seem equivalent to the joke about a manufacturer who says, "We lose on every item but make it up on volume," except that Hollywood has another way of making up the loss—the so-called back end, which includes home video (now mainly DVD) and TV licensing.

Home video is both more complex and more profitable. With the advent of the DVD, home video has become a vast retail business, with studios selling both new and past titles, as well as television programming such as The Sopranos, Friends, or Chappelle's Show, at wholesale prices that can go as low as $5 a DVD. Studios, which have meticulously analyzed these costs, estimate that manufacturing, shipping, and returns costs average 12.4 percent; marketing, advertising, and returns costs average 18.5 percent; and residuals paid to guilds and unions for their members and pension plans come to 2.65 percent. So, about two-thirds of video revenues are gross profits (which participants, such as stars, producers, and directors, may share in once the movie breaks even). In 2004, the studios' estimated video gross profit was $13.95 billion.

But the studios' real El Dorado is television. What makes television licensing, both at home and abroad, especially profitable for the studios is that virtually all the expenses required to market a television program, including tapes and advertising, are borne by the licensee. The studios only have to pay the residuals to the guilds and unions, which varies between movies and TV and average roughly 10 percent. The studios get to keep the other 90 percent. In 2004, this amounted to slightly more than $15.9 billion, making it the studios' single-richest source of profits.

This El Dorado comes from many tiers of the television industry. (Click here to see a table of this data.) In 2004, studios made $3.9 billion from licensing their films, shorts, and TV series to the American broadcast networks—all of which are now owned by the corporate parents of the studios, creating a cozy, not to say incestuous, relationship. Another $4 billion came from licensing studio films to pay-per-view TV. All the studios have an "output" arrangement with pay-per-view TV channels to sell them an entire slate of films at fixed prices. Warner Bros., for example, sells all its films to its corporate sibling HBO, and Paramount sells all its films to its corporate sibling Showtime. Overseas, almost all the main pay-per-view TV outlets are owned or controlled by the studios' corporate parents. Finally, $9.8 billion comes from so-called library sales, through which the studios license their movies and TV programs over and over again to cable networks, local stations, and foreign broadcasters. Fifty-nine percent of this immense $17.7 billion of revenue from television licensing comes from America, which is not surprising, considering that on an average day fewer than 2 percent of Americans go to movie theaters, while more than 90 percent watch something at home on TV. And without these profits from TV, no Hollywood studio could survive.

Even though the television profit center is often overshadowed by the public's fascination with box-office results, it accounts for the direction Hollywood is taking in three significant ways. First, it explains the relentless marriages between the principal outlets for profitable entertainment—TV networks—and the Hollywood studios, which have been television's primary content-providers since 1970. After Rupert Murdoch was unable to buy a network and boldly created his own Fox network, Michael Eisner bought both ABC and ESPN for Disney in 1995—a coup that changed not only Disney but the landscape of the entire entertainment economy. The other entertainment giants quickly followed suit. Today, the studios' corporate parents own or control all six over-the-air networks, as well as 64 cable networks, accounting for almost all the prime-time television audience. (Viacom, even after it is divided into two separate units, will be controlled by a single corporate parent—Sumner Redstone's National Amusement Inc.)

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