CKEC : The Hollywood threat

As a result of my position in CKEC, I have started paying attention to Hollywood news. Yesterday, there was an article about Hollywood partnering with DirecTV to roll out its premium video on demand (VOD) plan. The premium VOD plan will make movies available 2 months after theatrical release, and at least 1 month before it comes out on DVD, and will be priced at $30 per showing. Naturally, this plan has cinema owners screaming murder, and threatening to boycott movies. Personally, at the $30 price point, I think that the threat to box office earnings is minimal. Still, the article has set me thinking about the uneasy relationship between Hollywood and cinema owners, and the probable direction of the relationship.

DVD sales used to be Hollywood’s most profitable business. DVDs cost about a quarter to make, and are sold for $20-30, and the profit need not be shared with any other partner. In contrast, box office earnings have to be split with cinema owners, and DVD rentals have to be split with Blockbuster. The introduction of large TVs in the 2000s inspired many to begin assembling their own DVD movie library, and DVD sales exploded. In 2004, the New York Times reported that Hollywood made triple the profit from DVDs as they did at the box office. To capture more of the DVD gold, Hollywood began to shrink the DVD window from 6 months after theatrical release to 3 months. Ostensibly, this was done to reduce the loss of sales to piracy, but in fact, it was to shift movie consumption from a low margin channel to a high margin channel. The cinema owners were furious and threatened to boycott movies. In 2001, Regal boycotted Rush Hour 2, but this move was not copied by rival cinema owners, and Rush Hour 2 ended up doing okay in the box office despite the boycott. Last year, AMC threatened to boycott Alice in Wonderland when Disney wanted to shrink the DVD window to 3 months, but eventually came to a settlement and did not follow through with the boycott. There are two major reasons why the boycotts from cinema owners tend to fail. Firstly, only a few blockbuster movies and 3D movies still yield significant revenue after 2 months. The vast majority of movies are dropped after 2 months for newer movies, so there is really no significant incentive for cinema owners to fight for a longer DVD window for most movies. Secondly, a boycott by a cinema owner is a boon to rival cinema owners, so unless both Regal and AMC get seriously pissed off at the same time, a boycott with real impact to box office earnings is unlikely. That said, there is probably a line in the sand at the 2 month mark that will prompt all cinema owners to launch a boycott.

While Hollywood was fighting with the cinema owners, the sky caved in on DVD sales. The novelty of big screen TVs wore off, and DVD growth slowed. Netflix introduced a new, better business model for renting DVDs through mail that did not require holding massive amounts of physical DVD inventory, driving Blockbuster out of business and severely crimping DVD profits for Hollywood. Even worse, the millions of titles in Netflix’s library made people question the wisdom of assembling a personal movie library. Internet streaming means that many titles are now immediately available for viewing without even waiting for a DVD to arrive in the mail, further diminishing the need for a personal DVD library. Hollywood’s profitability began to drop dramatically, and it began to push the DVD window in the other direction, against Netflix and Redbox, demanding a 2-3 month period of exclusive DVD sales before releasing the DVDs for rental. Still, Hollywood is in an increasingly weak position. Movie production is a creative industry, where ideas are more important than capital and infrastructure. Creative industries such as movies and fashion tend to stay fragmented, faced with a constant influx of startups with new ideas. The structurally weak Hollywood is now caught between the Regal/AMC duopoly on one hand, and the Netflix monopoly on the other hand. Regal and AMC have already started talks on jointly bankrolling new movies. Hollywood’s last best hope, the HD-DVD/Blueray revolution, did not bring in anywhere near the profits given by the original DVD boom. My guess is that at this point, Hollywood probably derives equal amounts of profit from box office earnings and DVD sales at this point, and further squeezing of the cinema owners will be against the studio’s own interests.

The increasing market power of the cinema owners has allowed them to increase movie ticket prices at greater than the rate of inflation. Most of us can probably still remember the days when tickets cost $5 and a trip to the movies was comparable in price to taking the family out for dinner at a casual dining restaurant. Today, tickets cost above $10, and a night at the movies approaches the cost of dinner at a fine dining restaurant. In the future, I think that movie consumption will be split into 3 channels. The premium channel will be the cinematic experience. You get to be one of the first people to see a movie on a very large screen with many other similarly excited people, and for this privilege, you will pay $12-24 per person. The next rung down on the value chain will be the DVD-home theater experience. You pay $12-24 for a DVD which you can show to the entire family in the privacy of your own home on your big screen TV. While the movie is already 2-3 months old, and probably not in 3D, it is 2-3 times cheaper than a trip to the cinema. And finally, if you can wait 6 months to watch a movie, you get to watch it from Netflix at a rock bottom price of $5-10 per month, or just pick up a DVD at the discount bin for a similar price.

Disclosure : I have a position in CKEC.