The original title of my book was The Logic of Hollywood. I changed it because of the response it provoked. Everyone laughed, thinking I was being ironic or perverse. I found this near-universal reaction interesting in itself. After all, Hollywood totally dominates the world’s entertainment industry. Not only movies but television, video, games, and theme parks. It has created the celebrity culture that the media feeds off and obsesses over and through it has enormous power over the stereotypical picture the public receives. And, more to the point, the six studios that for all practical purposes are Hollywood--Warner Bros, Fox, Paramount, Sony, Disney, and Universal--get an internal rate of return on their capital of between 15 and 25 percent--which is profitability many great Industrial companies, like General Motors, can only envy. So why does the public assumed that such consistent power and profits proceed from a laughably illogical system?
One answer is there is scant information. The screenwriter William Goldman famously explained the movie business this way: nobody knows anything. He is right--up to this point. The studios obscure the true sources of their wealth. But the real conceptual confusion that make their decisions seem inexplicable proceeds from the generally held assumption that the movie business is about movies. It not about movies, it is about creating properties--including TV programs, cartoons, videos, and games--that can be sold in a multitude of markets that go well beyond the movie theaters. Of course, and this helps perpetuate the misunderstanding, Hollywood once--just two generations ago--was entirely about movies.
As late as 1948, there was a huge regular movie audience. 90 million Americans--65 percent of the population--went to a movie house in an average week. Most of these people didn't arrive at the neighborhood theater to see one particular film. They went to see a three-hour program that included newsreels; short comedy films, such as The Three Stooges; cliffhanger serials, such as Flash Gordon; a "B" feature, such as a Western; and finally, the main attraction. Nor were they driven to go to the movie house by national advertising. They went by habit, as they had done since silent movies. Movies were the only game in town.
The studios then had a pretty simple business model. All their money came from the proceeds of the tickets sold at movie houses. Over 90 percent from America and Canada. They didn’t have to worry about competition cutting into their cash harvest because they either owned or controlled. They could determine where, when, and for how long their films played. To make money, all they had to do was to keep a movie’s cost of production below what they got from the box-office. They collected an average of about 1.1 million per film. The cost for making and distributing it was $750,000, about $5 million in 2005 dollars.
They could easily keep the cost down because they owned the means of production. The studios, the props, and most important, the talent. The stars were their chattel, bound to them by long-term contracts that let them managed their careers.
But the entire studio system that sustained Hollywood collapsed in the early 1950s. There were three reasons.
First, the U.S. government broke up their monopoly over the theaters. In doing so, it not only destroyed their neat business model, it threw open the door to competition from independent and foreign film-makers.
Second, with this competition, the studio star system also died. Instead of studios strategically managing stars’ careers, a new breed of agents assumed this crucial function. Not only did this astronomically drive up the cost of making movies but, even more importantly, it deprived studios of the prestige and power that came with control over the celebrity culture.
Third, and most important, Hollywood lost its audience to television. Instead of paying to go to movie theaters, a large part of its audience choose to watch sports, games shows, and even movies at home for free. By the late 1950s, theaters had lost over 60 percent of their audience. Nothing worked to stop the continuing defections, not CinemaScope, not surround sound, not special effects, not epic movies, not even the fantasy movies or the movies of Spielberg or Lucas. By the late 1980s, even though the population had nearly doubled, annual ticket sales had fallen from 4.6 billion in 1948 to 1 billion. Even worse, the studios had to split this declining box-office with independent and foreign film-makers. In short, it was a disaster scenario for both the studios and now independently owned theaters.
To survive, Hollywood had to reinvent itself. How did it reinvent itself?
Since the studios could no longer count on habitual moviegoers to fill theaters, they created audiences for each and every different movie they released through TV advertising. It was not unlike an election campaign in which you needed to get voters to vote for your candidate on a specified day. The studios needed to get movie-goers on the opening date to go to the multiplexes and choose their movie. This required bombarding a target audience with very expensive thirty-second ads on national TV. For this to work, studios needed to find a target audience that both predictably clustered around a few program on which they could afford to buy time--usually seven ads in the week preceding the opening--and find one that could be motivated by this blitz to leave the comfort of their home on a weekend. And who was the only audience that satisfied both these conditions: Teenagers.
So they zeroed in on teens not because they necessary liked them, or wanted to make teen movies, or because teens ate buckets of popcorn, but because Teens were the only people that could efficiently reach and lasso for an opening.
The good news with this strategy was that they could now fill theaters on opening night and it saved the theaters from bankruptcy.
The bad news was that, on average, it turned to cost more just in advertising to rope in this audience than they were getting back from ticket sales. (Theaters keep about half the box-office). They also needed to pay astronomical cost to make the movies, of course. Obviously, this would be a formula for bankruptcy--if they depended on the box-office.
But the new Hollywood no longer had to depend on the box-office. With TV sets in every home, a huge home entertainment market beckoned. Indeed it became irresistible in light of this underlying reality: on any given night, less than 2 percent of Americans go to movie theaters while over 95 percent stay home to watch something on TV. Disney had been the first to license its products to TV. By the 1960s every studio had followed suit. Next, the studios had the good fortune of losing their suit against the VCR--so, by the 1980s, they also had a booming video market which quickly exceeded that of movie theaters.
Happily for the studios, the teen audience they recruited also proved to be the primary audience for video games and other licensable properties. So they found they could extend licensing profits. And there were profits--since unlike movies, on which they had to pay for advertising and prints, the licensee assumed these costs.
Fast Forward to Today
In 2005, the ticket sales from theaters provided less than 15 percent of the studios’ revenues in 2005. Home entertainment in the form of television, Pay-TV, DVD, and videos provided more than 85 percent of the studios' revenues in 2003. Movies despite the blinding allure they hold for the media, now serve essentially as launching platforms for licensing rights, much like the runways at haute couture fashion shows. The profits come from TV, DVD, and other forms of licensing.
In short, the logic of Hollywood was to follow the audience when it left the theaters to their home. The corporate parents of the studios meanwhile assured the success of transition by taking over the principal means of delivering TV into American homes. The six corporate parents now own or control all the six over-the-air broadcast networks and most of the cable networks, including ESPN. And in the near future you will see Hollywood’s products--which include TV programs and games--sold in myriad forms, including Video-On-Demand and ala carte downloads on personal digital recorders and telephones.
The economic logic, though powerful, is not relentless. Unlike the steel or oil industry, Hollywood also has a social logic. Many of the people who run the studios did not come to Hollywood just to make money--they could have gone into investment banking or hedge fund speculating if that was their ambition. They came to Hollywood also for the prestige that comes with identifying with the celebrity culture of stars and directors. But to achieve that objective they had to make something other than teen fantasy movies. They had to make the type of movies that would please stars, agents, directors and the award-granting community. So, yes, not everything Hollywood does fits in with the economic logic I described.
Edward Jay Epstein writes “The Hollywood Economist” column for Slate magazine.
