Casino Hollywood

Casino Hollywood

Casino Hollywood

Sept. 12 1997 3:30 AM

Casino Hollywood

Why movie studios are a lousy investment.

Here's a short course in the economics of the movie industry: Never have so many invested so much for so little. At a time when American corporations in general are enjoying historically large profit margins and double-digit annual growth rates, Hollywood confronts stagnant sales, declining viewership, and astonishingly low profit margins. The usual suspects--inflated salaries, inattention to costs, and competition from other media--can be blamed for some of the industry's woes. But, in large part, Hollywood's troubles are an object lesson in what happens when short-term gambling replaces long-term planning.

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Consider the recent announcement that Metro-Goldwyn-Mayer's current owners--billionaire Kirk Kerkorian and Australian media magnate Kerry Stokes--will offer 12.5 percent of the company to the public later this year. The IPO is expected to raise close to $250 million. Although any number of Wall Street execs counseled MGM against going public this soon (Goldman, Sachs actually refused to underwrite the IPO because it thought the deal was too hasty), the studio wants to reap the benefits of the bull market; it also wants the cash as quickly as possible. In inimitable Hollywood fashion, the IPO is scheduled to coincide with the release date of Tomorrow Never Dies, the studio's new James Bond film, because MGM figures that the free publicity will boost the stock price.

The painful truth is that the studio is probably right about the impact of the Bond film on the IPO, because the residual glamour of the movies is the only reason one could justify investing in MGM. The company is marketing itself as the only "pure play" movie investment, since other public companies that make movies are also involved in nonfilm businesses. Unfortunately, it's not clear that the "pure play" aspect of the company is a plus. It's especially dubious when one considers that MGM has released just one film, Hoodlum, since Kerkorian and Stokes bought the company in October 1996. Eleven months is a long time to go without cash flow when you've got hundreds of millions of dollars a year in overhead costs. Tomorrow Never Dies had better be a big hit.

This reliance on the success of one or two films is unique to MGM and to this year--the studio should have a full slate again in 1998--but it does epitomize the industry's new dependence on blockbusters. This year, nine summer pictures cost close to $100 million each; three more behemoths will open by Christmas. The only real successes among the summer releases were Men in Black, Air Force One, and The Lost World. But the size of those successes is worth keeping in mind. In domestic receipts alone, Sony should clear $150 million on Men in Black and close to $90 million on Air Force One, while Universal took home around $140 million for The Lost World. Toss in foreign sales, video, and merchandising, and the profits are enough to fund an entire studio's output for six months.

Illustration by Robert Neubecker

The equation here is simple enough, and helps explain why the $15-million thriller has become a thing of the past. If you can earn a 100-percent return on your investment, it's better to invest $90 million than $10 million. And even if you miss three out of every five times, you still may bring home enough from the two hits to stay profitable. In addition, the lack of accountability that dominates Hollywood encourages the managerial pursuit of self-interest. A studio executive who wants to safeguard his lifestyle has to be more interested in the size of the studio's production budget than in the bottom line. In other words, he lives better losing money on $450 million in sales than he would making money on $200 million.

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Conventional wisdom has it that this embrace of the blockbuster represents the ultimate triumph of commerce over art, dooming American movies to mediocrity. As director Rob Reiner put it: "[T]he studios aren't in the business of putting on shows but turning out product. And you can't make films as product." But there are a couple of rather gaping holes in this thesis. The first is that if movies are all about making money now, they're doing a very bad job of it. One analyst recently estimated that the return on capital in the industry is around 1.3 percent. The second is that the glory days of classic Hollywood cinema were precisely the days when the studios were most run like factories churning out a product. The vertical integration of the studio system mimicked the vertical integration of the auto and steel industries, as did the hierarchical chain of command. MGM directors, writers, and actors made the films they were told to make, or else they were suspended. And the movie industry was more popular--and more profitable--than it has been since.

In addition, almost all the philistinism for which Hollywood is attacked today--the reliance on big stars, the tendency to mimic rather than to innovate, the reliance on sequels--was characteristic of Hollywood's heyday as well. MGM was known for having "more stars than heaven." When Gone With the Wind was in production, other studios rushed to find other antebellum epics. And as far as sequels go, the Batman series doesn't compare with MGM's Andy Hardy series or Abbott and Costello, who starred in seven hits during 1941 and 1942.

What's really different is not the quality of the films but the control that the studios exercise over them. Before 1948, studios owned 70 percent of first-run urban theaters, which meant that they were in charge of production, distribution, and exhibition. At the same time, the studios used their oligopolistic power to force independent theater owners to screen B films if they also wanted to screen A films. That ensured a reliable flow of profits from movies that cost very little to make. But a series of antitrust decisions after World War II ended these practices and forced the studios to divest themselves of their theater holdings, while also encouraging the development of independent production companies. That, in turn, made most creative people in Hollywood independent contractors. And the studios became more involved in financing and distribution than in production.

None of these, on their own, were necessarily bad developments. The independent-producer system fostered competition, which theoretically should have increased efficiency. Creative people were freer to follow their hearts. The studios started to look something like publishing houses. You could argue, in fact, that the renaissance American movies experienced in the early 1970s was only possible because of these new arrangements. But in the long run, the disappearance of steady revenue from lower-cost productions and the lack of any permanent relationship between the studios and the people making the movies made high-priced gambling a logical--if disastrous--choice. Because every film is a one-shot, everyone involved has a stake in it being as big a shot as possible. This is hardly a recipe for sustained growth. In the simplest terms, no one is doing long-term planning because everyone's trying to make the next deal.

Still, it's worth remembering that, as late as 1987, the studios were still reaping huge profits. It's only in the last 10 years, in fact, that we've seen a meteoric rise in the costs of both production and marketing. In one sense, this is the full flowering of the death of the studio system and the triumph of purely speculative capitalism. In another sense, it's part of what's been called the "winner-take-all" society, where those on top command more and more resources and those in the middle tend to disappear. But what it isn't is a rational way to run an industry. It's not commerce that rules in Hollywood. It's just excess.