“Movies are like weather and by the time the flock of clones hits, the audience and the information cascade have drifted

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Fintage House BV

“Movies are like weather and by the time the flock of clones hits, the audience and the information cascade have drifted

away, like storm clouds following a sunny day.”

Alexander de Haas

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“The independent movie industry: research on the subject of forecasting producer’s revenues and return on investment.”

University: Groningen

Faculty: Business Management

Subject: Final thesis

Author: Alexander de Haas

1^st Mentor university: Dr. G. Gemser 2^nd Mentor university: Drs. J. Mol

Mentor Fintage House BV: Mr. M.P. Melchior

‘De auteur is verantwoordelijk voor de inhoud van het afstudeerverslag: het auteursrecht van het afstudeerverslag berust bij de auteur.’

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Executive Summary

Literature on forecasting the performance of films predominantly focusses on major studio productions. No research on forecasting the performance of independent films has been performed, due to the fact that data on independently produced films are hard to obtain. Fintage House operates in the independent movie industry. This company offers a service, which ensures that any party who has a financial interest in a film, from financier to profit participant and from actor to producer, will actually receive their share of the revenues; known as the collection account managent (CAM).

This department collects information from several parties involved, resulting in a unique database. As soon as Fintage House becomes involved in a project, a collection account (bank account) is opened in which the worldwide revenues of the film must be paid. Over the years Fintage House has distributed revenues on hundreds of film and television productions, resulting in the collection of, not only the worldwide revenues, but also valuable information from several important involved parties. Information on the amounts paid by distributors to exploit the rights of a film for a specific territory and for a specific period of time (the minimum guarantees); the production costs of each film (the budget); and the number of territories the film is sold to (distribution agreements). Information on other subjects of each film production, like box office gross; genre; talent; awards; reviews; user ratings; MPAA ratings; release periods; language; and theatrical releases; was collected via the Internet Movie Database. The CAM department at Fintage House is not yet profitable.

By performing research on the critical succes factors in independently produced films, the results may not only contribute to science, but also be relevant for Fintage House.

Fintage House aims at a forecasting model that improves the selection process of films. In addition, Fintage House aims at commercialisation of the forecasting model.

Thus the goal of this thesis reads:

“To create a model to forecast the producer’s (investor, financier) revenues and return on investment in time of an independent movie project, in order to advice Fintage House on selecting future projects and to advice Fintage House about the commercialisation of the results.”

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There is a big difference between major studio productions and independently produced films. The word “independent” indicates this difference. Within the independent movie industry, almost every party is represented by an independent company; the production company; the Sales Agent; and the distributor. A major studio represents all these parties, eliminating variables like minimum guarantees and distribution agreements, which are crucial in independent productions.

Correlation and regression methods are used to create the forecasting model. The operationalization of the dependent as well as the independent variables is primarily based on the operationalizations found in former studies. Four variables act as dependent variable. 1. the minimum guarantees; 2. the ROI (minimum guarantees divided by the budget of each film); 3. the box office gross; and 4. the ROI (box office gross divided by the budget of each film).

By running multiple regressions the following forecasting model can be created:

Financial Variables

Minimum Guarantees ROI in terms of M.G. Box Office Gross ROI in terms of B.O.

Budget + Budget - Reviews + Summer +

A-star + English language - Kids + Kids +

B-star + US theatrical release + Awardsnomimations + A-director + Release territories + Release territories + A-director +

A-director + (Eastern +)

(Summer +)

(Awardspast -)

Based on the empirical results the following conclusions can be made. Minimum guarantee is positively related to the budget, an A-star, B-star and the number of release territories. Fintage House should focus on films that possess these characteristics when selecting films, because the height of the minimum guarantees will have its effect in the height of the fee collected by Fintage House. Furthermore the results indicate that the return on investment in terms of minimum guarantees is positively related to a theatrical release in the United States, the number of release territories and the contribution of an A-director. Producers of independent films should therefore focus on these findings in order to obtain a higher return on investment.

Fintage House may commercialize the results of this study, however instead of keeping the results exclusively to themselves, it may also be a good strategy to make

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the results available for the general public by publishing the results in scientific and/

or industry journals. Specific journals such as Variety, Screen international and the Independent. This free publicity may result in the extension of the brand awareness of Fintage House. In my opinion publication gives a good signal to the industry that a company like Fintage House is performing research to identify critical success factors in the independent movie industry and thus aims at high quality products (film projects).

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Preface

I have written this master thesis for Fintage House BV and the University of Groningen and by accomplishing it, I have fulfilled the requirements for the Master of Science “Financial Value Management” at the Faculty of Management and Organisation in Groningen.

About six months ago I started with my master thesis at Fintage House BV.

Nervousness, anxiety and eagerness were aspects that ran trough my mind; this was something new. During the research process I learned a lot, for example how to use my own mind and put theoretical frameworks from theory into practice.

Theoretically speaking, I could not have made it to this final thesis without the support of my mentor at the university of Groningen, dr. G. Gemser. Her good advice, support and her understanding about the movie business helped me a great deal, for which I am very thankful.

Practically speaking the outcome of my research would have been much less interesting without the ideas and guidance of my mentor at Fintage House, mr. M.

Melchior. The brainstorming sessions, the time he made available, while working on a tight schedule, was of an enormous help to me and I am very grateful to him!

Last but not least I would like to thank my father, for he is the reason I could do research in the movie industry at the first place. He made it possible for me to

complete my study at a company which core competence is the movie business. After this experience I am triggered even more to make a future in the movie business.

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1.1 RESEARCH BACKGROUND _________________________________________ 12 1.2 PROBLEM DESCRIPTION___________________________________________ 14 1.3 DEFINITIONS ___________________________________________________ 15 1.4 LIMITATIONS___________________________________________________ 16 1.5 METHODOLOGY_________________________________________________ 16 1.5.1 DATA SOURCES_________________________________________________ 17 1.5.2 METHOD OF ANALYSIS AND OUTCOME OF THE REPORT____________________ 18 1.6 STRUCTURE AND STAGING RESEARCH ________________________________ 18

CHAPTER 2 INDEPENDENT MOVIE INDUSTRY______________________ 19

2.1 HISTORY INDEPENDENT MOVIE INDUSTRY_____________________________ 19 2.2 PROCESS OF DEMAND AND SUPPLY___________________________________ 21 2.3 CONCLUSION___________________________________________________ 24

CHAPTER 3 THEORETICAL FRAMEWORK _________________________ 25

3.1 THEORIES _____________________________________________________ 25 3.2 VARIABLES_____________________________________________________ 28 3.2.1 DEPENDENT VARIABLES__________________________________________ 28 3.2.2 INDEPENDENT VARIABLES_________________________________________ 31 3.2.2.1 Production budget ____________________________________________ 31 3.2.2.2 Critic’s review _______________________________________________ 32 3.2.2.3 Genre______________________________________________________ 33 3.2.2.4 Presence or absence of talent ____________________________________ 34 3.2.2.5 Awards ____________________________________________________ 35 3.2.2.6 MPAA ratings _______________________________________________ 36 3.2.2.7 Release date_________________________________________________ 37 3.2.2.8 Release territories ____________________________________________ 38 3.2.2.9 Language ___________________________________________________ 39 3.2.2.10 User ratings_________________________________________________ 40 3.2.2.11 Conclusion _________________________________________________ 40 3.3 CONCEPTUAL MODEL_____________________________________________ 41 3.3.1 EXPLANATION CONCEPTUAL MODEL_________________________________ 42

CHAPTER 4 METHODOLOGY _____________________________________ 43

4.1 COLLECTING DATA______________________________________________ 43

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4.2 PROCESSING DATA_______________________________________________ 45 4.3 ANALYZING DATA_______________________________________________ 45 4.4 OPERATIONALIZATION OF THE VARIABLES____________________________ 47 4.4.1 THE DEPENDENT VARIABLES_______________________________________ 47 4.4.2 INDEPENDENT VARIABLES_________________________________________ 50 4.4.2.1 Budget _____________________________________________________ 50 4.4.2.2 Critic’s review _______________________________________________ 50 4.4.2.3 MPAA Ratings ______________________________________________ 51 4.4.2.4 Language ___________________________________________________ 51 4.4.2.5 Genre______________________________________________________ 51 4.4.2.6 Talent _____________________________________________________ 52 4.4.2.7 Awards ____________________________________________________ 54 4.4.2.8 Release Date ________________________________________________ 55 4.4.2.9 Release Territory _____________________________________________ 55 4.5 CONCLUSION___________________________________________________ 56

CHAPTER 5 RESULTS_______________ ERROR! BOOKMARK NOT DEFINED.

5.1 DESCRIPTIVE STATISTICS _________________ ERROR! BOOKMARK NOT DEFINED. 5.2 BIVARIATE CORRELATIONS________________ ERROR! BOOKMARK NOT DEFINED. 5.3 REGRESSION ANALYSES___________________ ERROR! BOOKMARK NOT DEFINED. 5.4 CONCLUSION___________________________ ERROR! BOOKMARK NOT DEFINED.

CHAPTER 6 CONCLUSION AND RECOMMENDATIONSERROR! BOOKMARK NOT DEFINED

6.1 CONCLUSIONS __________________________ ERROR! BOOKMARK NOT DEFINED. 6.2 RECOMMENDATIONS_____________________ ERROR! BOOKMARK NOT DEFINED. 6.2.1 RECOMMENDATIONS TOWARDS FINTAGE HOUSEERROR! BOOKMARK NOT DEFINED. 6.2.2 RECOMMENDATIONS FUTURE RESEARCH____ ERROR! BOOKMARK NOT DEFINED. REFERENCES _____________________________________________________ 57

APPENDIX A INDEX________________ ERROR! BOOKMARK NOT DEFINED.

APPENDIX B SAMPLE ______________ ERROR! BOOKMARK NOT DEFINED.

APPENDIX C DIRECTOR____________ ERROR! BOOKMARK NOT DEFINED.

APPENDIX D-1 A-ACTOR ____________ ERROR! BOOKMARK NOT DEFINED.

APPENDIX D-2 A-ACTRESS __________ ERROR! BOOKMARK NOT DEFINED.

APPENDIX D-3 B-ACTOR ____________ ERROR! BOOKMARK NOT DEFINED.

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APPENDIX D-4 B-ACTRESS __________ ERROR! BOOKMARK NOT DEFINED.

APPENDIX E SURVEY ______________ ERROR! BOOKMARK NOT DEFINED.

APPENDIX F FINTAGE HOUSE BV ___ ERROR! BOOKMARK NOT DEFINED.

APPENDIX G INCOME PATTERN ____ ERROR! BOOKMARK NOT DEFINED.

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Introduction

The motion picture “Finding Nemo” is record breaking at the box office. Pixar and Disney have produced such a successful animated picture, one not seen since the blockbuster “The Lion King”. The magical result of the animated motion picture became possible through a co-production agreement between the independent production company Pixar and the major film studio Disney. In this special construction Pixar accounted for the production of the animated picture, while Disney took the distribution and prints and advertising costs on its account. “Finding Nemo”

collected already over $350 million in the United States alone, with only a $94 million production budget. Nonetheless “ego gratification” rather than money may often be the only return on an investment in a film. In fact, of any ten major theatrical films produced, on average, six or seven may be broadly characterized as unprofitable.

Furthermore, the success ratio for studios is considerably better than for individual participants; which is the case in independent produced motion pictures¹.

There are a number of reasons for an economic analysis of the demand for the production of movies. A motion picture is one of the best examples of the differentiated product envisioned in conventional models of monopolistic competition. As the production of a movie represents a major investment and has a substantial uncertainty over its prospective revenues², it is not surprising to find that over the years a wide variety of research has been done with the prospect of reaching models that are able to determine and forecast the success of a film. Ancient industry wisdom tells us that motion picture audiences and box office (B.O.) revenues are strongly uncertain. It is only with the development of the science of complexity that we can begin to grasp, what every producer awaiting first weekend box office reports about his movie has always known; the business is terrifyingly uncertain³. To illustrate this uncertainty the following quotes are given:

1 Vogel: 2001, page 35

2 Smith and Smith: 1986, page 501

3 De Vany: 1997, page 2

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Producer Robert Evans once said: “A film is like no other product…it only goes around once. It is like a parachute jump. If it doesn’t open, you are dead.”⁴

An unknown philosopher once said: “Movies are like weather and by the time the flock of clones’ hits, the audience and the information cascade have drifted away, like storm clouds following a sunny day.”⁵

The crucial question within the movie industry would be: “What makes a film a success?” In this thesis the focus will be on what the critical success factors will be in an independent movie production. In the movie industry no one knows for sure what the ingredients for success are, but every research increases the information needed so badly.

Next to the study of the critical success factors in the independent movie industry, an extra research solitarily for Fintage House has been done, a description of which can be found in Appendix G. The results of this study are only valid for Fintage House and cannot be generalized. They are thus of limited scientific relevance; hence this has been placed to the Appendix.

4 De Vany and Walls: 1996, page 1493

5 www.quotationspage.com

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Chapter 1 Research objective

This chapter starts with the research background. The research background consists of a description of the reasons that have lead Fintage House BV to create this assignment. The goal arising from the research background will be set forth in the next paragraph, the problem description. In Paragraph 1.3 a list of definitions will be given and in Paragraph 1.4 the limitations of this research will be described. Finally in the last paragraph an introduction of the methodology of the research will be given. A complete description of the methodology is given in Chapter Four.

1.1 Research background

A lot of research has been done on the global movie industry. Forecasting future gross box-office revenues and researching the influence of individuals, from talent to film critics, on box-office success are examples that reveal only a fraction of what has been done. However not much specific research has been done on the independent movie industry, which my thesis is all about (the difference between major studio productions and independent motion pictures is discussed in Chapter Two). The motion picture industry in general has some unique characteristics that make it very interesting from the perspective of research on new product forecasting. Hundreds of new movies are launched every year. Demand for a new movie is highly uncertain, since each movie is “experiential”, and it is difficult for consumers to evaluate the quality of a movie until they have actually experienced it. Due to the uncertainty in the entire movie industry the (commercial) value of accurate forecasts is extremely high⁶.

Fintage House BV is a company that offers financial services. The company has several departments (see for further description Appendix F), but the department that deals directly with the independent movie industry is the Collection Account Management Department (CAM). The parties who have a direct financial interest in a film or TV project appoint a collection account manager of Fintage House through an agreement. The core of this collection account management agreement consists of two

6 Sawhney and Eliashberg: 1996, page 114

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instructions. The first one is to instruct the Sales Agent to have the distributors pay directly into the collection account. The second one is to instruct the collection account manager about receipt, allocation and payment of the revenues.

The collection account manager ensures that every party who has a financial interest in a film, from financier to profit participant and from actor to producer, will receive its share of the revenues – provided however that revenues are indeed being generated. All the revenues of a movie project are collected in a collection account.

Revenues include for example minimum guarantees, which are specific amounts paid by distributors to exploit the rights of a movie project for a specific period for their specific territory. Also overages are distinguished as revenues; these are the “extra”

revenues received after the distributor has recouped its minimum guarantee and print and advertising costs (see for further explanation Chapter Two). The overages are regarded as “extra” due to the fact that the independent productions seldom gain overages.

It appears that not only the forecasting of future revenues is relevant for the movie industry, but also relevant for Fintage House itself. The reason for Fintage House to create this assignment is that Fintage House has a valuable database. The uniqueness of the database is that Fintage House has financial information on a large number of independent movie projects, to which no other firm worldwide has access.

Information like budgets, minimum guarantees and parties (territories) involved are the most important ones stored in the database. An important goal of this master thesis is to analyse this unique information and provide an advice for Fintage House whether this information can be commercialized. On the basis of the information made available by Fintage House, producers, investors, financiers and others with a financial interest in the film industry, may, for example, make better decisions regarding their involvement in film projects. In addition an advice can be given to Fintage House about the projects they have to aim at in the future; higher minimum guarantees means higher revenues resulting in a higher net profit for Fintage House, assuming that the CAM fee percentage is the equivalent (the CAM department receives a bargained percentage for services offered, CAM fee, from the total revenues collected on the account; see for further explanation Appendix F).

Valuable information would not only be crucial to Fintage House, but also to investors and producers in the independent movie industry. So the research could have

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a positive effect for the internal strategy as well as the external strategy (marketable results to the outside world).

1.2 Problem description

In this paragraph a description of the research goal and the research questions will be given. Previous studies focussed on explaining and/ or forecasting success of major studio productions. However, this empirical research focuses on creating a model to stipulate the critical success factors for independent motion picture productions from the producer’s (investor, financier) point of view.

Goal:

To create a model to forecast the producer’s (investor, financier) revenues and return on investment in time of an independent movie project, in order to advice Fintage House on selecting future projects and to advice Fintage House about the commercialisation of the results.

Question:

Is it possible to forecast the producer’s (investor, financier) revenues and return on investment in time of an independent movie project, and if so, what forecasting model can be created?

Sub questions:

To give a structured answer on the main question above, the following sub questions should be answered:

1. Why is forecasting the producer’s revenues and return on investment relevant for Fintage House?

2. Which variables are relevant in this research?

3. What effect do these variables have?

4. What forecasting model can be created?

5. In what way is the outcome relevant for Fintage House and can these results be commercialized?

6. What advice can be given to Fintage House?

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Research methods

The table displayed below shows which research methods will be applied to the several sub questions. It states which method is used to reach an answer to the specific sub questions.

Sub question Key word Research

1 Relevance forecasting ROI Literature study and interviews 2 Classification variables Literature study

3 Effects of variables Correlation and regression analysis 4 Forecasting model Correlation and regression analysis 5 Outcome relevance FH Literature study and interviews 6 Advice

Table 1.1 Research

1.3 Definitions

- Collection fees: These are the Collection Account Management fee incomes for Fintage House; the agreed percentage of the CAM account.

- Gross Receipts: The total amount received in a collection account for a specific movie; minimum guarantees and overages.

- Budget: The total production costs (does not include the print and advertising costs). This should exclude any estimate of bank fees, bank interest, and legal fees on the production loan. It should include a full 10% contingency and completion guarantee fee and a projected cash flow schedule referencing the projected draw dates under the proposed facility.

- Minimum guarantee: The amount paid by the distributor to the sales agent to exploit all the rights of the movie for a certain territory and for a certain period of time.

- ROI: The return on investment in this thesis is calculated by comparing the budget with the minimum guarantees that are paid to the sales agent, before interest or taxes, sales commission and expenses or collection fees and expenses. Furthermore the ROI in terms of box office gross is calculated by comparing the budget with the worldwide box office gross.

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- Major studios: Production companies trying to fit a pre-existing audience⁷. Majors concentrate on the “high concept” formulas for creating blockbusters⁸. - Independent movie: Litman (1994) defines independent movies as follows: the independent movie is not the “high concept” mass-market movies that are financed and produced by the major studios with the objective of becoming blockbusters. Thus, there is a strong sense independent and major were defined in contrast to one another⁹.

- Fractured-rights deals (split-right deals): These are deals whereby a studio or an independent producer produces a movie and the studio decides to distribute this production only in North America. For the distribution in territories in the rest of the world independent Sales Agents and distributors will be contacted¹⁰.

1.4 Limitations

In the research assignment there are two limitations:

- Whilst Fintage House BV focuses on several financial services in the entertainment business, this research assignment will only focus on the Collection Account Management (CAM) department.

- Research will only be done in the Independent movie industry.

1.5 Methodology

This paragraph will give a brief introduction on the methodology in this research. The description reflects the method and completion of the collected data, the identification and operationalization of the relevant hypotheses and variables through the means of former studies, and the method of analysis. A complete description of the methodology will be presented in Chapter Four.

7 Levy: 1999, page 23

8 Litman: 1994

9 Zuckerman and Kim: 2003, page 35

10 Vogel: 2001

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1.5.1 Data sources

To be able to answer the questions a broad area of data sources needs to be consulted.

The documentation at Fintage House, literature and interviews are the three main sources to collect information.

First of all there are the databases provided by Fintage House, which include the central Contract Management System database (CMS) and a few sub databases, like Lotus Approach and the Collection Account Management (CAM) database. CMS was started by Fintage House prior to my research, but is far from complete. Variables as budget, MPAA rating, genre, talent, viewer rating and minimum guarantees are not included. Information about these variables was provided by examining documentation at Fintage House and the Internet movie database (IMDB). IMDB is, according to the movie-times website, by far the best movie database. It has been described as the database where one can find; “everything you might want to know, and even stuff you don’t about any movie you want.”¹¹

The second source is literature. To identify the relevant variables used in this research, a literature study of former research has been performed (see Chapter Three).

Different authors have done research about several subjects relating to the major film studio industry, while little research has been done on the independent movie industry. A few of the previous studies have dealt with specific relating subjects or show such a resemblance that similar variables are used in this thesis. However, some of the variables in this research are created due to the fact that this research aims at independent movie productions, instead of major studio productions. After the description of the used variables in this research, hypotheses will be formulated on the basis of former studies.

The last data source is interviews. In order to determine the relevance for Fintage House of not only the goals, but also of the results in this research, interviews will be held with three managers of the Collection Account Service department, as displayed in Appendix E.

11 www.the-movie-times.com

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1.5.2 Method of analysis and outcome of the report

The analyses of the variables will be done by correlation and regression. A regression line is often used with a given value of the clarified variable χ to predict the clarifying variable γ. This is most clear when the regression reflects a cause and effect relationship and that r² (the square of the correlation coefficient) is that large that changes in χ for the main part explain the variation in γ. However, for successful forecasting a causal effect is not required¹². In this research the goal is, using these statistical techniques, to forecast the revenues and return on investment in terms of minimum guarantees and box office gross of an independent movie production.

By formulating and subsequently testing hypotheses on a 1%, 5% and 10%

significance level, statements about the critical success variables of independent movie projects can be made. When the results are, from Fintage House’s point of view, potentially of interest to parties who have or will have a financial interest in movies, and they will be of the required value, the results will be commercialised.

1.6 Structure and staging research

The thesis is structured as follows:

Chapter One will contain the research plan of the assignment. The background of the research and the problem description are the two main issues. An introduction of the independent movie industry will be given in Chapter Two. Chapter Three will represent the theoretical framework. Furthermore, the theories, methods and models used in this research will be set forth. The variables that will be used during the research are displayed and explained. Finally hypotheses will be drawn up. Chapter Four deals with the methodology of the research. In Chapter Five the results from the research will be described and underpinned. Finally in the Sixth Chapter a conclusion is given and recommendations will be made to Fintage House.

12 Moore and McCabe: 1993, page 143 (r² is that fraction of the variation in the y-values that is being explained by the smallest square regression from y on x)

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Chapter 2 Independent Movie Industry

This Chapter contains an introduction in the independent movie industry. The difference between major studio productions and the independently produced movies will be described; also the process of selling an independent movie production will be described and explained; this is mainly done to illustrate the importance of the minimum guarantees.

2.1 History independent movie industry

The movie industry in general has, from an economic point of view, grown tremendously in the past fifty years. With the evolution of the media (like television, radio and cinema) the movie industry increased enormously. It has become a billion dollar industry with so-called major studios and independent producers. Prior to the 1980s, most movies were produced by major studios or large independent filmmakers in affiliation with the majors. The advent of cheap computing power led to technological changes in filming and production processes, reducing the costs of film- making considerably, and leading to an explosion of small independent films. Since the mid-1980s small independents films have outnumbered those produced by major studios and affiliated large independents¹³. The types of independent films and filmmakers are myriad. Some small independent producers make multiple films, building large portfolios of film projects and essentially making their living through a continuous string of projects. On the other end of the spectrum are films made by individuals trying to break into the business. The failure rate for these is quite high, with many of these films never reaching any significant audience¹⁴. Of the increased movies produced by small independent filmmakers a vast majority of these never enjoy a box-office release. For these films without box-office earnings, their income, if any, comes from the secondary markets of domestic or foreign television, and video distribution. Whilst the movies produced by major studios and independents affiliated with these studios do have box-office earnings¹⁵. With affiliated independents is meant the so-called mini-majors; production companies that act as independents but

13 Rusco and Walls: 2003, page 4

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have an apparent relation with a major studio, such as Miramax (independent) being a daughter company of Warner Bros (major studio).

The results of a study done by Zuckerman and Kim indicate that major and independent distributors have different tendencies to distribute films in certain genres¹⁶. Major studios focus on primarily action, adventure and thrillers, while independents focus on documentary and drama films (more details specified in Chapter Three). It seems quite clear that major and independent films are quite different products, the former appealing to a mass audience with high-concept marketing, the latter to a more specialized one with different tastes. It is tempting to view the distinction between independent and major as reflecting a division between highbrow and lowbrow art¹⁷.

The financial performance of a movie is unpredictable because each one is unique and enters competition for audiences in a constantly shifting marketing environment¹⁸. Conventional wisdom in Hollywood states that success or failure of each new feature film is impossible to predict. Each film has a dual nature in that it is both an artistic statement and a commercial product. As such, those in Hollywood have often scorned an analytical approach to predicting box office success¹⁹. As it is a very risky business it is hard, if not impossible, to predict (forecast) the future revenues of a movie project²⁰. However, there is some short-term forecasting²¹. No matter how difficult, it would be useful, as it is also a commercial business, to know something about what factors and conditions affect the financial performance of movies for those who invest in them²². There are several ways to look at the financial/ economic success of a movie, many variables are possible i.e. box office gross, gross video rentals, TV gross. This thesis deals with the financial performance of independently produced film projects. In the independent movie industry the risks and the process of incurring costs and generating revenues is quite different compared to these processes within the major studios, such as MGM, Universal, and DreamWorks, to name but a few.

This difference occurs because the major studios own/ control most links in the value

18 Vogel: 2001, page 97

19 Sochay: 1994, page 1

20 Ross, Westerfield and Jaffe: 2002, page 387

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chain of producing a movie. They often control the process from production to distribution. As a result of this there are no sales agents and no minimum guarantees will have to be paid to distributors such as is the case in independently produced films. In an independent production however, most links in the value chain are represented by a different independent company. The links in the chain undergo the concept of supply and demand resulting in minimum guarantees and the splitting of overages. In other words, major studios and their affiliate independent filmmakers are essentially vertically integrated with the distribution chain. Small independents, on the other hand, most often sell the rights to their films outright to independent third-party distributors. In this case, the payment to the filmmaker already represents the net earnings of the producer²³, the so-called minimum guarantees.

The minimum guarantee is the amount paid by a distributor to a sales agent, who acts on behalf of the independent production company, for the rights of a movie for a specific territory, and a specific period. This difference is the reason for the creation of a specific set of variables specifically related to the independent movie industry.

2.2 Process of demand and supply

First of all a diagram showing the cash flow between the parties involved in an independent film production will be presented in figure 2.1²⁴.

The first and most important player in the independent movie industry is the producer.

This individual, or company, will produce a specific movie for a certain amount of money; the budget. In general, a long time before the movie is completed, or when the time is right, the producer contacts a sales agent. This sales agent intents to sell the exploitation rights of the film internationally. The sales agent will, in the producer’s interest, visit different festivals in the world to try to sell the movie to as many territories as possible, and for each territory to the highest bidding distributor. It is in the sales agent’s own interest to sell it for the highest possible price, the minimum guarantee, because he or she will get a percentage of this amount when received (the remainder of the minimum guarantee goes to the producer). Apart from the sales commission the sales agent will receive a compensation for its sales expenses. The sales agent sells the movie to the distributor for a certain territory, for a certain period

24 http://akmi-kek.gr/akmimedia/DEAL%20STRUCTURES.pdf

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of time, and for the exploitation in certain media (Theatrical, TV, Video, Pay TV and Cable TV etc.)

Figure 2.1 Cash flow allocation

A distributor buys the movie for the exploitation of all the media channels in a certain territory, as shown in figure 2.1. The sum he pays for the movie is the so-called minimum guarantee. To reach a minimum guarantee, negotiations are required. In the negotiations between the sales agent and the distributors the sales agent tries to sell the rights of the movie for the highest possible price, while the distributors try to buy the movie for the lowest possible price. Every territory around the world offers several distributors, who compete for the same territory. For a certain territory the sales agent will probably choose the distributor who offers the highest minimum guarantee. This distributor pays this minimum guarantee to the sales agent and will distribute the movie to all the possible media in his territory. The distributor will pay for the prints (the actual physical cans with copies of the film) and advertising costs

Box office Video stores

Libraries Museums Colleges Airlines Broadcast

TV Pay TV

Exhibitor’s share

Regional distributors

Homevideo company

Non theatrical distributors

International distributors

Production company

Profit participants

Investors Sales agent

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(“p&a”) in order to promote the movie the best way he can, hopefully resulting in high revenues, in first instance from the theatrical exploitation. The movie generates a certain amount of revenues in the distributor’s territory, which can be allocated to the three following different sources of revenues:

1. The box office receipts will partly go to the real estate owner or exhibitor of the cinema and the remainder will go to the distributor. Box office grosses are shared between distributor and exhibitor on a sliding scale that typically begins at 90%-10%

in favor of the distributor, and progresses to 50%-50% several weeks into the life cycle²⁵.

2. In case of Video and DVD rentals a part of the gross will be allocated to the video storeowner (the retailer, the wholesaler) and the remainders will go to the distributor and the producer of the motion picture.

3. In case of a TV release, the TV station will pay a certain amount to the distributor;

this process will be the same in the case of cable TV and pay TV.

After the print and advertising costs and the amount paid as minimum guarantee are recouped, the rest of the profit, the so-called “overages”, if there are any, will be split between the distributor and the producer, via the sales agent, through whom the world wide revenues are paid to the producer. This split will be based on a distribution agreement.

Between the producer (through the sales agent as his representative) and the distributor several kinds of deals can be reached. In most cases the deal is based on a minimum guarantee. This way the distributor will take a larger risk; he pays both the minimum guarantee and the costs for print & advertising. The extra risk will have its effect in the allocation of the overages; high percentage of the overages for the distributor and a low percentage of the overages for the producer. There could also be a deal on the basis of a gross deal and P&A. This means that the producer will not receive a minimum guarantee (so his investment is the budget of the film) and the distributor will only be responsible for the P&A. This way the producer takes more risk and the distributor takes less risk, which will have its effect on the splitting of the overages. The substantial extra risk is, for the distributor in the first deal and for the

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producer in the latter deal, in most cases, fatal. As a result of this a high degree of bankruptcy among the distributors as well as the producers occurs. The average life cycle of independent production companies and distributors is approximately five years. All the movies used in the sample of this thesis are based on distribution agreements using minimum guarantees.

2.3 Conclusion

The conclusion can be drawn that the risk in the independent movie industry is enormous and the need for information is large. As De Vany states in his study;

“Hollywood” is a place of false expectations, dashed hopes, and unbelievable success, because the movies are a complex system. Many people do not understand the complexity in the movies and why that makes “Hollywood” such an uncertain place²⁶. As shown the independent movie industry is even more complex than major studio productions. For this reason the independent movie industry is even more uncertain.

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Chapter 3 Theoretical Framework

Chapter One described the goal of this thesis. The problem description showed that several variables have to be formulated and analysed during this research. The method of analysing will be explained in Chapter Four.

In the first paragraph a description will be given, and a comparison is made to similar research. The second paragraph describes the variables used in this thesis. The variables used in former studies and the results of these studies are the central issues and are set forth in several sub paragraphs. Each sub paragraphs is concluded with relating hypotheses. Finally a conceptual model, showing the positive and negative relations between the dependent and the independent variables, will be presented in the last paragraph.

3.1 Theories

The unpredictability of the success of movies and the large investments often made, result in a high need for information²⁷. Much research has been carried out, because a lot of data on film performance is easily attainable. Within these studies the applied methods of research are often the same, but the final results appear to be very diverse.

Several different approaches have been taken. Litman and Kohl (1989) categorized these differing studies along two main approaches: The first is the communication theory, which focuses on individual decision-making processes to engage in movie going. The second one is the economic approach. The economic approach to exploring motion picture performance focuses on collective movie attendance decisions. The economic approach looks at more than just the content of a film by examining the institutional factors that affect the supply of films. These factors include patterns and timing of release, distribution and marketing expertise, and film financing. By focussing on aggregate data and incorporating the supply side of the film industry, the economic approach seeks to explore the variables that influence the financial performance of motion pictures, rather than the behavioural aspects of individual decision-making²⁸. The communication approach will not be dealt with. In this research the focus will be on the economic approach. Furthermore, all former

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studies adressed in this research are studies related to the economic approach. Studies performed by Basuroy, Chatterjee & Ravid; De Vany and Walls (3); Eliashberg and Shugan; Ravid; Rusco and Walls; Sawhney and Eliashberg; Sochay; and Zuckerman and Kim; are discussed in short and continue to show up in the further part of this thesis.

- Basuroy, Chatterjee & Ravid (2003) studied the effects of film critics, star power and budgets on box office gross. They found that for the first eight weeks both positive and negative reviews were significantly correlated with box office revenues.

Furthermore they found that negative reviews hurt revenue more than positive reviews help revenue in the early weeks of a film’s release. Their last finding suggests that stars and budgets moderate the impact of critical reviews²⁹.

- De Vany and Walls (1996) tied the information dynamics of motion picture audiences to the dynamics of the distribution of motion picture weekly box office revenues for the top 50 films. They found that neither genre nor stars can guarantee success and a disaster can bankrupt a studio. More importantly they found that the industry’s market institutions and sophisticated contracts promote the information dynamics that discover extraordinary motion pictures and let supply and pricing adapt to capture the strongly increasing returns they create³⁰.

- De Vany and Walls (2002) questioned if Hollywood makes too many R-rated movies. They conclude that too many R-rated motion pictures are produced. They found that putting a star in a movie does increase the size of the box office opening, which puts a floor on its box-office revenues, but a high budget, R-rated (MPAA rating, see for further explanation page 50), star movie raises the studio’s odds of suffering large losses and lowers its chances of making large profits. Furthermore they claim that one must give up the quest for accurate forecasts and learn to live with the probabilities³¹.

- De Vany and Walls (2003) investigated the stable distribution as a model of profit in motion pictures. They support the curse of the superstar (if a superstar extracts a fee equal to the expected profit then the movie almost surely will lose money). They find

29 Basuroy, Chatterjee and Ravid: 2003, page 116

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that blockbuster movies that have already attained high profit have expectations of even higher profit and this prospect does not diminish as profit grows³².

- Eliashberg and Shugan (1997) studied the effect of film critics. They show empirically that critical reviews correlate with late and cumulative box office receipts but do not have a significant correlation with early box office receipts³³.

- Ravid (1999) explored a possible role for stars and other potential informational signals in the movie business. He showed that stars play no role in the financial success of a film. Big-budgets, more reviews, G- and PG- ratings, and sequels lead to higher revenues³⁴.

- Rusco and Walls (2003) studied the effect of independent film finance, pre-sale agreements and the distribution of film earnings. They found that low budget contract films (independents) that are actually completed appear to have a lower probability of unprofitability compared to completed major studio contract films³⁵.

- Sawhney and Eliashberg (1996) created a parsimonious model for forecasting gross box office revenues of motion pictures. They show that box office potential is positively influenced by the presence of a major star; awareness inherited by sequels;

and positive critic’s review. A movie which has an R rating ultimately result in poorer box office prospects³⁶.

- Sochay (1994) examined the performance of motion pictures. He found that Christmas and summer releases; Oscars won and Oscar nominations; stars; rating by critics; comedies; and the number of screens; are all positively correlated with the rental revenues of a film. Furthermore an R-rated film was negatively significant³⁷. - Zuckerman and Kim (2003) studied the critical trade off between identity assignment and box office success in the feature film industry. Their results suggest that to succeed in breaking out an independent film must become regarded as belonging to the multiplex, rather than the art house. They find that the number of reviews is positively correlated with the cumulative box office gross of major as well as the independently produced films. They find that the genre crime has a negative effect on the cumulative box office gross³⁸.

32 De Vany and Walls: 2003, page 1050-1055

33 Eliashberg and Shugan: 1997, page 68

34 Ravid: 1999, page 488

35 Rusco and Walls 2003: page 13

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In the next paragraphs the variables used in former studies and the relating results of these studies will be set forth. The hypotheses set out in the following paragraphs are based on the results of these former studies.

3.2 Variables

Paragraph 3.2.1 will give a description of the dependent variables used in former studies. Furthermore a selection of independent variables has been made and will be explained on the basis of former studies, which is situated in paragraph 3.2.2.

3.2.1 Dependent variables

The minimum guarantee and the Return On Investment (ROI) rates in terms of minimum guarantees act as the dependent variables in this research. In addition the box office gross and the ROI in terms of box office gross act as dependent variable.

Former studies, focusing on major studio productions, usually work with gross box office or gross video rentals. During its lifetime a movie project collects revenues from different sources. If the movie has a theatrical release, the producer/ distributor receives revenues from the box office. If the movie has been sold to a video store the producer/ distributor receives revenues from Video and DVD rentals. If the movie has been sold to a TV station, the producer/ distributor receives revenues from the Pay TV, Cable TV and Public TV. So there are several sources from which the movie generates revenues. To study the success of a movie it would be possible to choose one of these sources or all of them. Either using variables like box office revenues, video/DVD revenues or TV revenues, the results state something about the success of a movie at the audience (i.e. the movie attendance determines the quantity of the revenues). If on the other hand minimum guarantees are used as a dependent variable, the results will tell nothing about the success of the movie at the audience, but about the success for the producer. The producer will receive a bargained amount of money (the minimum guarantee) for selling the rights of a movie for a specific territory to a distributor. Due to this pre-sale the production company will receive the minimum guarantees before the movie is released, automatically excluding the relation between the success of the movie at the box office or other secondary markets.

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The level of the minimum guarantee is obviously based on the distributor’s sales expectations. The level of the minimum guarantee received divided by the budget of the movie project determines the success ratio of the movie for the producer; the return on investment (ROI) of the initial investment made by the producer (investor, financier). For example, the total revenues flow from the minimum guarantees equals

$4,000,000 and the budget of the film equals $3,000,000, the success ratio, or the producer’s ROI will become:

000 , 000 , 3

000 , 000 ,

4 = 1,33

There are several possibilities in choosing the dependent variable. Ravid, for example, used the return on investment (ROI) rate as a dependent variable. Ravid collected financial data of a sample of 175 films, namely the domestic and international video revenues and the domestic box office receipts resulting in the following ROI equation:

total revenues/production costs = 1 + return on initial investment³⁹. Ravid used the ROI as a dependent variable to predict profitability (which is scarcely used in other studies). Ravid also used the domestic box office receipts, video sales revenues, the share of domestic distributors in box office receipts overseas and the sum of all revenues from all sources as a dependent variable, to predict revenues. Rusco and Walls used the box-office revenues and the stream of residual earnings as a dependent variable. The box-office revenues are the cumulative earnings from theatrical release, and the residual earnings are the present discounted value of the stream of residual payments that come due when a film is released to secondary markets, such as video and free or pay television⁴⁰. Zuckerman and Kim used the cumulative box-office gross as a dependent variable. This variable does not reflect the profitability of the film but its success in cultivating demand⁴¹ (revenues); cumulative box office gross estimates the dollars earned through sales at the box office. Sochay used two dependent variables namely the distributor film rentals (RENTs) and the length of run (LOR) of each film. RENTs were a measure of the domestic (United Stated and Canada) rentals accruing to distributors. LOR was the number of weeks a film remained on Variety’s weekly edition of the “50 Top Grossing Films” list⁴². It appears that studies using revenues, such as box office gross and rental revenues, far exceed studies using

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profitability variables, such as the return on investment rate. In this study both revenues and return on investment rates function as dependent variables.

The dependent variables, as discussed, were used in order to determine the success of a movie at the audience. Revenues are collected through several channels (see Chapter Two for further explanation) and these channels were all used as dependent variables in previous studies. The following channels are most important:

- Box office gross. Used by Basuroy, Chatterjee and Ravid; De Vany and Walls (1996); De Vany and Walls (2002); De Vany and Walls (2003); Eliashberg and Shugan; Ravid; Rusco and Walls; Sawhney and Eliashberg; and Zuckerman and Kim.

- Rental revenues. Used by Ravid and Sochay.

- Returns. Used by De Vany and Walls (2002) and Ravid.

In this study minimum guarantees and box office revenues function as dependent variables. In the independent movie industry the minimum guarantee represents the gross box office as well as the gross video rentals as well as the gross TV broadcasting; as the minimum guarantees are paid by distributors all over the world (the movie is sold to as many territories as possible), the minimum guarantees determine the success for the producer. In addition, the distributor bases the minimum guarantee he is willing to pay for the specific movie on the success he thinks the movie will have at the box office, video store and TV broadcasting. So the reasoning for success by the distributor determines the level of the minimum guarantee for his territory. If one would examine the market from the distributor’s point of view, statements about relations between success and, for example, box office revenues can be made. Due to the difficulty of acquiring the data of not only minimum guarantees, but also the print and advertising costs and the revenue factor, like box office revenues or video/DVD rental revenues, the research of forecasting the distributor’s return on investment would be difficult, but most interesting. While this issue is beyond the scope of this thesis, it does indicate an interesting direction for future research.

In this study the focus will be on the producer’s return on investment; the level of minimum guarantee minus the initial investment, the budget. Subsequently the focus

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will be on return on investment rather than revenues. However the variable minimum guarantee will also be used as a dependent variable to examine the relation between the independent variables and the revenues (minimum guarantees) of an independent movie production. The results of this regression are important for Fintage House, as higher minimum guarantees result in higher revenues (see Appendix F for further explanation).

Furthermore the box office revenues and the ROI in terms of box office gross will act as dependent variables resulting in statements about the success of the independent film production at the audience. Important note within this research is that it concerns a sub-sample, as the required box office reports were only attainable for a specific amount of films in the selection.

3.2.2 Independent variables

In former studies the commercial success of a films has been examined by studying the impact of a wide range of factors. These factors, or independent variables, will be discussed below.

3.2.2.1 Production budget

The cost of the production of a film is also known as the production budget, or the negative costs⁴³. Negative costs are the sum of the various costs, charges, and expenses incurred in the acquisition and production of a motion picture. These include such items as facilities (sound stage, film lab, editing room, etc) and raw material such as set construction, raw film stock, etc.⁴⁴. Production budget is, in major productions, often used as a signal to the consumers; stating a relation between the production budget and the quality of the film. To calculate returns the budget is used as a dependent variable in an equation. Ravid used these negative costs (budget) as the denominator in his equation; however, he also used the budget as an independent variable in his analysis⁴⁵. His results state that big budget may signal high revenues, regardless of the source of spending⁴⁶. Ravid (1999) and John, Ravid and Sunder (quoted in Basuroy, Chatterjee and Ravid, 2003) show that though big budgets are

44 Vogel: 2001, page 426

45 Ravid: 1999, page 474

46 Ravid: 1999, page 488

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correlated with higher revenue, they are not correlated with returns. If anything, low- budget films appear to have higher returns⁴⁷. Rusco and Walls find that low-budget films (independents) appear to have a lower probability of unprofitability compared to major studio films⁴⁸. Basuroy, Chatterjee and Ravid found that for the first four weeks the budget was significantly related to the revenues; after four weeks it becomes insignificant⁴⁹.

In this research the budget is used as the denominator in the equation of the producer’s return on investment in terms of minimum guarantees and box office gross. According to the findings in previous studies the following hypothesis can be formulated:

1 .

H1 = Bigger budgets result in higher revenues and lower ROI rates in terms of minimum guarantees and box office gross of independent movies.

3.2.2.2 Critic’s review

Critics play a significant role in consumers’ decisions in many industries⁵⁰. The role of critics may be most prominent in the film industry⁵¹. One expects that positive critic reviews will lead to more success, however empirical research shows altered results. Eliashberg and Shugan find that reviewers do not influence the success of a film but are a good predictor of it⁵². Ravid found that the more reviews a film receives, the higher the revenues⁵³. Basuroy, Chatterjee and Ravid found a negative bias, that is, negative reviews hurt performance more than positive reviews help performance, but only during the first week of a film’s run⁵⁴. A possible explanation of more reviews is that whether the reviews are positive, neutral, or negative, the reviews create publicity and ultimately results in a higher number of visitors at the box office.

In the context of this study, the variable critic’s reviews may seem irrelevant since the review of critics have no direct influence whatsoever on the level of minimum guarantee, due to the fact that the minimum guarantees are agreed before the film is released. However, there are many cases, for example the two movies about

51 Eliashberg and Shugan: 1997, page 68

52 Ravid: 1999, page 482

53 Ravid: 1999, page 488

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“Alexander the Great” that are currently still in the pre-production and principal photography stage, where preliminary reviews are given, while “the critics” never saw the movie⁵⁵. There are also cases in which movies are sold to a certain territory while the movie already has been released in another territory. So there are cases (films) in which reviews are already published, which will have its effect on the level of minimum guarantee. However, due to the fact that the preliminary reviews are no

“real” reviews and because there are just a few movie projects in the database of Fintage House, which conform to the latter case, this variable will be excluded from the research when regressions with minimum guarantees are run. However, the variable is included to determine the relationship between the number of reviews and their effect on box office gross. Important note is here that in this research the focus will be on the total reviews rather than a distinction between positive and negative ones. The literature is inconclusive with regard to this distinction, however there are obvious references to the extent of the influence of the total reviews a film receives.

This is important because it states something about the marketing aspect of the movie;

more reviews means more publicity. Hence the following hypothesis can be formulated:

1 .

H2 = More reviews will lead to higher revenues and ROI rates in terms of box office gross of independent movies

3.2.2.3 Genre

The following types of origin are common in the movie industry⁵⁶: Action, Adventure, Animation, Comedy, Crime, Drama, Family, Fantasy, Horror, Musical, Mystery, Romance, Science Fiction, Thriller, War and Western. It is alluring to assume that the type of genre could have a major influence in the success of a movie production. Sochay found that Science fiction and Horror films would generate higher rental revenues⁵⁷. Ravid (2002) found that family films, shared under the wing of children’s films, generate higher box office revenues. Zuckerman and Kim found that films with the genre crime were negatively significant to cumulative box office gross⁵⁸. Sawhney and Eliashberg found no significant relations between the box office revenues and the genre. It would be relevant, in this research, to analyse the effect of

55 www.empireonline.co.uk

56 www.imdb.com

58 Zuckerman and Kim:2003, page 54

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the genres on the dependent variables. On the basis of the results in previous studies the following hypotheses can be formulated:

1 .

H3 = Science fiction, horror and children’s films will have a positive effect on the return on investment and the revenues in terms of minimum guarantees and box office gross of an independent film.

2 .

H3 = Crime films will have a negative effect on the revenues and return on investment of independent films in terms of minimum guarantees and box office gross.

3.2.2.4 Presence or absence of talent

Talent enfolds the writer, director and the actors. In this research the variables director and actor/actress will be included. The variable talent-writer will not be included, due to the absence of (financial) data to create profound selection criteria for writers.

Litman (1983) found that the presence of a star (director and actors) had no significant impact on box office rentals; Litman and Kohl (1989) however found that there was a significant relation between star actors/top directors and major studio film rentals.

Studies by Litman and Ahn (1998), Wallace, Steigerman, and Holbrook (1993), Sochay (1994), and Prag and Casavant (1994) all find the same positive relationship as Litman and Kohl (1989) found⁵⁹. However, a recent study done by Ravid found no significance between the box office revenues and returns (profit) and the presence of a

“bankable” star⁶⁰. Zuckerman and Kim also created three indicators of a film’s “star power”: the number of actors (or producers or directors) in the film who appeared in any of the ten top grossing films from 1987 to 1996. They found no relationship between the box office revenues and the presence or absence of a “bankable” star⁶¹. Sawhney and Eliashberg found a positive significant relationship between the presence of major stars and the box office revenues⁶². As shown, former studies found different results concerning “star” participation in the movies. Due to the fact that, above all, less “bankable stars” appear in independent movie projects⁶³, it would be interesting to find out what the effect is of the presence of a “bankable star” in an independent production. The data for the actors and actresses are categorized into

60 Ravid:1999, page 480, 483

63 www.screendaily.com

“Movies are like weather and by the time the flock of clones hits, the audience and the information cascade have drifted

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