Motion Pictures: Competition, Distribution and Efficiencies

Chapter 8

Motion Pictures: Competition, Distribution and Efficiencies

StanleyI. Ornstein

Introduction

The history of the motion picture industry spans over 100 years. During that period the industry has endured competitive challenges from network television, cable and satellite, massive corporate reorganizations, and years of government and private antitrust attacks. Since the passage of the Sherman Antitrust Act in 1890, few industries have been so drastically altered by government antitrust action as the motion picture industry. But it has survived, gaining prosperity through technological improvements in filmmaking and exhibition, and by capitalizing on new channels for distributing movies. Born from innovations in the photography of moving objects and the projection of images onto a screen, the industry rose from humble beginnings in the 1890s. The first theatrical screening was in New York City in 1896, following a vaudeville act. Movie viewing was widespread by 1910, and reached enormous popularity in the 1920s, 1930s and 1940s. In the 1930s and 1940s upwards of 400-500 feature films were produced per year in the United States, and theater attendance in many years reportedly averaged eight-five to ninety million per week, or over four billion annually, well above contemporary attendance levels of approximately 1.4 to1.6 billion.1

Following World War II, the vertically integrated structure of the top movie distributors, with common ownership of production, distribution, and exhibition, was dissolved by government antitrust actions, and, under court order, many of the industry’s well-established marketing and distribution practices, such as "block booking," "blind bidding," and exclusive dealing franchise arrangements were prohibited.2 Movies then faced the challenge of network television, which some believed would destroy the movie business. With declining theater attendance, thousands of motion picture theaters were closed. However, over the last thirty years the industry has rebounded, capitalizing on the introduction of videocassettes, DVDs, and pay cable television; experiencing huge growth in foreign revenues; and attaining a post-1970 peak in North American theatrical admissions in 2002 of 1.64 billion.

1

This study offers an overview of the industry’s evolution – its organizational structure, marketing and distribution practices, alleged antitrust transgressions, responses to forced dissolution, and contemporary economic performance. Industry studies provide an opportunity to broaden our understanding of economic practices. The motion picture industry provides vivid examples of prominent economic phenomena, including vertical integration, exclusive dealing, price discrimination, and adaptations to inherently risky investments. The courts' dissolution of the industry’s vertically integrated structure and curtailment of various distribution practices in 1948 provides a natural before-and-after experiment for examining the factors leading to vertical integration and the consequences of abandoning such integration. Price discrimination has been an integral part of the motion picture industry for over seventy-five years. As we will see, the demand for movies lends itself to price discrimination, and practices arose to exploit this opportunity. Finally, the movie business is very risky. The box office outcome of any given movie is highly uncertain. The risk of investing in movies has had a substantial effect on the industry's business practices, structure, and evolution.

Production, Distribution, and Exhibition

The movie industry traditionally operates at three levels: 1) production – the financing, development, and making of motion pictures; 2) distribution – the licensing, distribution, and promotion of movies; and 3) exhibition – the screening of movies. All three stages are obviously highly dependent on one another. Until the 1950s, the top five studios were vertically integrated companies, combining production, distribution, and exhibition. In 1948 the U.S. Supreme Court, in effect, required the top five studios to divest their ownership of movie theaters and halt a variety of distribution practices for violations of the Sherman Antitrust Act, destroying an integral part of their organizational structure and thereby increasing the costs of distributing movies.3

Table 8.1 lists the major studio-distributors of films and their relative shares over time of domestic box office revenues (known as "rentals"). Columbia, Twentieth Century Fox, MGM/UA, Paramount, Universal, and Warner Brothers have been major distributors since at least the 1920s and 1930s. As seen from the changing shares, the distributors’ fortunes have risen and fallen over time, as blockbuster movies have propelled first one and then another distributor to the top in various years. However, as noted, the success of movies is uncertain, with the majority of movies losing money. The major hit movies must earn enough to compensate for the many losing investments. Distributors are generally unable to maintain a number one position for more than a few consecutive years, indicating how difficult it is to consistently produce and distribute hit movies. As one example, Sony (Columbia/Tri-Star) reported a $3.2 billion loss on its movie operations in 1994.4 Sony had a series of poorly performing movies, gaining only nine percent of theater rentals. However, Sony scored with major successes in 1997, propelling it to a top rental share of twenty percent. The hits disappeared from 1999 to 2001, Sony's share fell back to approximately nine percent, but it was again on top with a seventeen percent share in 2002. Similar large swings are evident in the box office shares of other major studios.

<TABLE 8.1 NEAR HERE>

Motion pictures are rented under license to exhibitors, with the box office receipts divided in an agreed proportion between distributor and exhibitor. The distributor receives a percentage of box office receipts, with the percentage declining the longer the movie runs. In one type of first-run movie license the distributor receives seventy percent of box office receipts for the first week or two, with the percentage declining weekly thereafter. Under another formula for first-run movies, the theater owner receives a negotiated sum to cover overhead expenses, and the box office is split ninety/ten for the distributor in the first few weeks, with the distributor's share declining over time. These revenue shares are important since most movies earn the majority of their box office receipts within the first three to four weeks. On average, studio-distributors receive approximately fifty percent of box office receipts, although this can vary widely over movies and time. Profits from theater concession good sales (popcorn, candy, soft drinks, video games, etc.) go solely to the exhibitor.5

Leading exhibitor firms in 2005 are shown in Table 8.2. The top ten exhibitors account for approximately fiftypercent of all screens in the United States. Exhibition has experienced large-scale consolidation through mergers and acquisitions since the early 1980s, and through internal expansion by the largest exhibitors. The largest theater chain in 2005, Regal, began in 1989, grew primarily by acquisition until the mid-1990s, and then grew by a combination of acquisitions and new theater construction. Loews Cineplex resulted from the 1998 merger of Sony's Loews Theaters, with approximately 900 screens, and Cineplex Odeon, with approximately 1,600 screens. AMC and Loews were acquired independently in 2004 and taken private, and in January 2006 they merged, solidifying AMC's second place position.With the merger, the two largest exhibitor chains own approximately thirty-onepercent of all U.S. screens. Others, such as Cinemark USA and National Amusements, have also grown through acquisitions. As a result of differences across firms in acquisitions and new theater construction programs, the size ranking of exhibitors has shifted dramatically since the 1980s, producing increasing concentration in screen ownership.

The growth in number of screens has outpaced the rise in attendance for years. This was especially true in the 1990s. A construction boom in theaters from 1994 to 1999 added over 10,000 new screens. The leading firms incurred large debt, which resulted in a series of theater firm bankruptcy filings in 1999 and 2000. Firms falling into bankruptcy reorganization included such leading firms as Regal, Carmike, Loews Cineplex, United Artists, and General Cinema; major regional firms like Edwards and Silver Cinemas; and smaller chains.6 Some chains planned over twenty percent reductions in their total screens. With large excess capacity in screens and efforts through bankruptcy reorganization to regain profitability, hundreds of older screens were closed, with little increase in the total number of screens from 1999 through 2004.

<TABLE 8.2 NEAR HERE>

1

These two tables illustrate the dynamic nature of the motion picture industry. Intense competition and the vagaries of individual movie success change the rankings of distributors, generally from year to year. In theater exhibition, changes in ownership due to acquisitions and bankruptcies have fostered greater concentration in ownership and changed the fortunes of individual firms. We will return to contemporary industry developments and performance later in this study. However, we start with industry history, for to understand the industry today one needs to examine its historic development.

Early History

At the inception of the industry, manufacturers of motion picture cameras and projectors produced the movies, for in order to sell their equipment they had to supply movies.7 The movies were short, one-reel episodes of five to twenty minutes in length. They could be drama, westerns, comedy, or outdoor scenic movies. Movies were sold outright to exhibitors and viewed by individuals in penny arcades or in theaters along with vaudeville acts. Movies soon graduated to modest theaters for showings, known as nickelodeons for their five-cent admission fee, and thousands of nickelodeons opened throughout the country. Exchange firms arose to facilitate movie trading among exhibitors who sought variety in movie viewing for their customers, and as a means to reduce the costs of acquiring movies. Exchange firms evolved into early versions of modern day distributors, acquiring movies from producers and renting them to exhibitors. By 1911 there were a reported 150 exchanges (distributors) and 11,500 movie theaters in the United States. There were also dozens of motion picture producers. Movie theater chains were forming, and where they dominated local markets through movie booking agencies, some thought they exercised monopsony power, using that power in bargaining with distributors on movie rental rates.8

Feature length films of four- and five-reel length, replacing the short one-reel movies, were widespread by 1913. To attract larger audiences, theaters became more lavish in architecture and size, and in providing patrons with more amenities and comforts. Distributors, in turn, grew more sophisticated in selecting theaters for each movie and in setting rental rates according to theater size and location.

1

At the same time that theaters and distributors were multiplying rapidly, ten manufacturers of patented movie equipment formed the Motion Picture Patents Company in 1908 as a means to eliminate what had been years of intra-industry patent infringement lawsuits, and also in an attempt to exclude competition in the production, distribution, and marketing of movies.9 The Motion Picture Patents Company's attempts to monopolize the industry failed; however, it pioneered in various aspects of movie distribution. The Motion Picture Patents Company vertically integrated into distribution in 1910 in an attempt to monopolize distribution, forming the General Film Company, which acquired most of its former independent distributors. The General Film Company established for the first time a national distribution system of film rentals, classifications of theaters, time periods or “runs” for first-run, second-run, third-run, etc. movies, and geographic zones or “clearances,” which amount to exclusive exhibition territories for a given movie. Although it was innovative in distribution practices to maximize revenues, the company failed to move into feature film production, hastening its demise. The Motion Picture Patents Company was dissolved in 1918, after being found guilty in 1915 of attempting to monopolize the motion picture industry and after losing major patent lawsuits. Long before its dissolution, however, numerous new entrants had successfully challenged the Motion Picture Patents Company in all phases of the business: the manufacturing of cameras and projectors, and in movie production, distribution, and exhibition.

As one example of new entry, Paramount Pictures was formed in 1914 by combining five distribution-exchanges and regional distributors. Paramount secured contracts to distribute movies for three leading production companies. For its distribution services, Paramount retained thirty-five percent of the box office receipts it received from exhibitors, similar to the fees charged by distributors today. Paramount secured exhibitors for its producers, forming franchise or exclusive dealing relationships with exhibitors who screened Paramount’s full line of movies. Paramount also helped finance new production by providing advances to producers against box office receipts and by contracting with exhibitors for future play dates.10

1

By 1914, blocks of movies for an entire year (block booking) were being licensed to distributors and exhibitors, requiring exhibitors to take lesser movies in order to receive movies scheduled to have appearances by the leading movie stars of the day. In addition to Paramount, other national distributors included Mutual, Universal, and Fox. As noted, the Motion Picture Patents Company’s early attempt to monopolize failed primarily due to widespread entry from rival producers, distributors, and exhibitors. But the company pioneered in vertical integration between production and distribution and in the distribution practices—runs and clearances—that provided the basis for price discrimination.

Vertical Integration

From 1915 to the 1930s there was large-scale vertical integration into production, distribution, and exhibition. Movie production studios integrated forward into distribution and exhibition, distributors integrated into production and exhibition, and exhibitor groups integrated backward into distribution and production. In 1916 the Famous Players-Lasky studio bought Paramount, the distribution company, and in 1919 started vertically integrating into theaters, acquiring 300 theaters by mid-1921. In 1917 theater owners organized the First National Exhibitors Circuit to act as a purchasing agent for movies, and vertically integrated into distribution and movie production. By 1920 over 600 theaters were in the group. Eventually its best theaters were acquired by Famous Players-Lasky-Paramount, which became Paramount Pictures. Other theater chains integrating backward into distribution and production included Fox, which became Twentieth Century Fox in the 1930s, and Loews Theaters, which first acquired Metro in the 1920s. Loews/Metro put together the studios that became Metro-Goldwyn-Mayer (MGM). In the late 1920s, Warner Brothers, which pioneered in the first sound motion pictures, invested heavily in theaters, acquiring 500 theaters by the mid-1930s. A fifth vertically integrated studio, RKO, was formed in 1929 by the Radio Corporation of American (RCA) in order to sell sound equipment to movie producers, and it eventually acquired approximately 200 theaters.

1

These studios—Paramount, Twentieth Century Fox, Loews (MGM), Warner Brothers, and RKO—controlled the bulk of first-run theaters in large and small cities in the 1930s and 1940s through ownership, leases, or franchise (exclusive dealing) contracts with independent theaters. The five major theater-owning studios cross-licensed each other’s movies in cities or areas where they did not own theaters. Theater ownership as of 1945, both individually and jointly, is shown in Table 8.3. The number of theaters owned by the vertically integrated firms represented about twenty-four percent of the approximately 18,000 U.S. theaters in 1945. The top five distributors accounted for seventy percent of first-run theaters in the ninety-two largest market areas (100,000 population and above), and approximately sixty percent of first-run theaters in cities of 25,000 to 100,000, generating the vast majority of movie revenues. The top eight distributors, which included Columbia, Universal, and United Artists (although these firms did not own theaters), accounted for ninety-five percent of film rental payments to distributors over the period 1935 to 1944.11

<TABLE 8.3 NEAR HERE>

Vertical integration was adopted during a period of intense competition, as a more efficient means of distributing and marketing movies. Numerous firms challenged the Motion Picture Patents Company during its attempt to monopolize the movie industry. Producers competed for major stars to enhance box office appeal, in the quality of movies produced, and for the best distributors and exhibitors. Exhibitors and distributors competed for box office receipts and for the best movies. Firms sought to reduce costs and enhance demand by integrating into two or all three levels of production, distribution, and exhibition. A variety of factors drove this movement to vertical integration. First, producers integrated into distribution, seeking greater control over the licensing, promotion, and theater placement of their movies. Second, according to some commentators, producers and distributors became concerned about contracting for exhibition outlets, fearing they would be foreclosed from the best outlets once exhibitors integrated backward into production, as in the case of the First National Exhibitors Circuit. By integrating into exhibition, producers had a secure network of outlets in at least some parts of the country. With guaranteed distribution and exhibition, producers could more easily finance movie production. In similar fashion, exhibitors were concerned about gaining an adequate supply of movies when producer-distributors integrated forward into exhibition, fearing they would lose movies to the distributor-owned theaters. By integrating backward into production and distribution, exhibitors sought to gain a secure supply of movies. However, such concerns were questionable. Self-sufficiency in the supply of movies for exhibition is not a tenable competitive position. Exhibitors and distributors want the best movies, regardless of source. No firm with exhibition outlets has ever been able to rely solely on its own movies as a source of supply.