The Hollywood Economist (12 page)

As with
Mission: Impossible
, Cruise’s company produced the film, and Cruise, who proved to be a relentlessly focused producer, brought
Mission: Impossible 2
in on budget. The movie went on to be an even bigger success than the original, earning more than a half-billion dollars at the box office and selling over 20 million DVDs. Cruise’s share amounted to $92 million—and he was now
the key element in Paramount’s most profitable franchise. In light of such a success, Paramount initially agreed on the same deal with Cruise for
Mission: Impossible 3
. Even with Cruise’s rich cut, Paramount would make money. According to an internal analysis by Paramount, each DVD, which retails for about $15 wholesale, costs the company only $4.10 to manufacture, distribute, and market. Another 45 cents goes for residuals payments to the guilds, unions, and pension plans, leaving the studio with slightly over $10. So, even after giving Cruise his cut of $1.80 per DVD, Paramount stood to make more than $8 per DVD.

By 2004, DVDs were bringing into the studios’ coffers more than twice as much money as the theatrical release of movies, and there was every reason to assume that
Mission: Impossible 3
would sell more DVDs than its predecessor. The budget, however, had increased to $180 million, so new Paramount studio chief, Brad Grey, asked for a renegotiation. After the dust had cleared, Cruise still had his huge percentage of the gross—it actually had improved since there were now no other gross participants. When released in 2006, the movie took in $397.8 million at the box office (nearly 70 percent of which came from foreign theaters)—
which was less than the prior sequel—but Cruise’s real profit came in his huge 12 percent cut of DVD sales. As it turned out, Cruise was now making much more from the franchise than Paramount, a disparity that so infuriated Paramount owner Sumner Redstone that he terminated Cruise’s contract with Paramount in August 2006.

But Cruise did not go unemployed. MGM hired him in November 2006 to revive United Artists, a studio originally created in 1916 by such legendary Hollywood stars as Charlie Chaplin, Mary Pickford, and Douglas Fairbanks, Jr. but which had been dormant for twenty years. Merrill Lynch organized a $500 million line of credit to finance this enterprise. Whether or not Cruise can relaunch a moribund studio remains to be seen, but Cruise, as one of the handful of producers—along with George Lucas, Steven Spielberg, and Jerry Bruckheimer—who can reliably deliver a billion-dollar franchise, may yet succeed.

In 2005, I became an expert witness in a Hollywood lawsuit that in nearly five years managed to
consume over $20 million in legal fees. (And, as of 2010, an appeal is sill pending.) The heart of this Dickensian litigation was a contract between an author and producer for the making of
Sahara
, a $130 million action movie released in 2005 that starred Penelope Cruz and Matthew McConaughey, and was directed by Breck Eisner (the son of ex-Disney chairman Michael Eisner). The plaintiff was the author Clive Cussler, who had sold the film rights to his 1992 bestselling book
Sahara
for $10 million, and charged in his suit that his right to approve the final script had not been honored. He was represented in this suit by Hollywood lawyer Bertram Fields, who, according to his legend, had never lost a case (which is less impressive than it sounds because most Hollywood cases are settled out of court and the results are sealed). The defendant was Crusader Entertainment, a production company owned by oil tycoon Philip Anschutz, who, aside from his media properties, owned the majority stake in Regal Entertainment, America’s largest movie theater chain. Anschutz, who was listed by
Forbes
as the thirty-sixth richest man in America with $8 billion in assets, was represented by O’Melveny & Myers, a legal powerhouse, which according to
American Lawyer
, had the top-rated litigation department in the country.
The two law firms were located almost directly across the street from one another on the Avenue of the Stars in Century City, which once was the back lot of 20th Century Fox.

O’Melveny & Myers star litigator Alan Rader, who co-managed the
Sahara
case, retained me as an expert witness in 2005. He said that he had read my writings on the logic of Hollywood and wanted me to objectively lay out for the jury, possibly in a PowerPoint presentation, the economic reality behind the movie business. To prepare, I had to review a vast array of contracts, distribution deals, financial analyses, and other paperwork that might help me explain the requisites of the movie business. I also had to provide a lengthy deposition in Bert Field’s offices. Then, after years of convoluted maneuvering, the case actually went to trial, a rarity in Hollywood law. Six weeks later, the jury provided a surprise ending to the drama: Bert Field, the man who putatively never lost a case, lost big for his client. Clive Cussler was ordered not only to pay Anschutz’s company $5 million for undermining the success of the movie, but he had to pay him a staggering $13.9 million to cover his legal costs. In addition to this $18.9 million, Cussler also had to pay his own legal bill to Bert Fields, which presumably was also sizable.

Leaving aside the brilliant lawyering on both sides, the material I reviewed provided me with a key insight into how Hollywood works: the movie-business is a fee-driven business. When viewed from the outside, movies, which are almost always set up as separate off-the-books entities, rarely, if ever, show a profit. Nevertheless, when viewed from the inside, they serve as vessels for collecting and dispensing billions of dollars in fees. In 2008, the fees from studio movies alone exceeded $8 billion. And these fees support a large part of the Hollywood community, including directors, stars, producers, and screenwriters, as well as the talent agents, business managers, and lawyers who represent them. But most of these fees are paid only if the production is approved, or green-lit, by a studio willing to finance it. So the big players in Hollywood, and their representatives, have a powerful incentive to use whatever means at their disposal to pressure studio executives into green-lighting their projects. For their part, studios also get a rich fee, a distribution fee, which allows then to take a percentage off the top from every dollar that comes from every source including theaters, in-flight entertainment, DVDs, and television licensing. This percentage can be as high as 33 percent or as low as 10 percent depending on the relative
negotiating strength of each party. Before giving the green-light, studios run the numbers to make sure that their distribution fee has a good chance of covering their outlay, even if the film itself is unprofitable for others. Once a studio provides a green-light, the studio deposits money in its account, and the production can pay all the fees and salaries necessary to make the movie.

How do studios get the money to finance this fee-driven economy? To begin with, they raise a substantial part this sum by wheeling and dealing with outside parties. This includes negotiating tax credit deals around the world with financial groups needing tax relief, lease-back deals on copyright of the titles, pre-sales agreements to sell rights to foreign markers, product placement deals with corporations to insert their product or brands in their films, and hedge fund investments. This deal-making employs a large part of the entertainment law establishment who churn out the necessary paperwork. It also often provides, depending on the film, between 20 and 60 percent of the budget. For the balance of the money, studios either use their cash flow from previous films or borrow from banks through their revolving lines of credit at banks, called “revolvers,” assuming, based on their financial analysis, that they will earn back this portion of the outlay from their own distribution fee.

Of course, sometimes studios miscalculate and lose money. So do independent production companies, which lack the fee rake-off. And
Sahara
famously lost money—at least for its production company and its owner, billionaire Philip Anschutz. But not for everyone who worked on it. The actors, extras, make-up artists, hair stylists, costumers, assistant directors, set designers, animal wranglers, carpenters, cameramen, grips, editors, musicians, dialogue coaches, sound engineers, caterers, drivers, and publicists all got paid. The stars, director, and writers also got their fixed compensation (though they may never see any part of their contingent compensation, or profit participation). Paramount, which distributed the movie, got its fee. Clive Cussler even got his $10 million. And of course the lawyers on both sides got their fee, as did this expert witness.

The 81st Academy Awards, with its scripted speeches by stars, tearful acceptances, eulogies to the rich and the dead, red-carpet celebrity fashion show, and gold-dipped statuettes, had the same mission that the ceremony did when Louis B. Mayer convinced the other studio moguls to create the event in 1927 to “establish the industry in the public’s mind as a respectable institution.” Now, televised by ABC in dazzling high-definition
color, the evening-long informational furthers the long-standing myth that Hollywood is in the business of making great—and original—movies.

This illusion, like all successful deceptions, requires misdirecting the audience’s attention from the reality of how Hollywood makes its money to a few brilliant aberrations. Take the 2009 best-picture nominations:
Milk, Frost/Nixon, The Curious Case of Benjamin Button, The Reader
, and
Slumdog Millionaire
. What all these films have in common is that they have little to do with the real business of the Hollywood studios, which is global openings on 3,000 or more screens of youth-oriented movies that, after a few weeks in the multiplexes, can be mass-marketed on DVDs. For the Hollywood elite to choose these atypically adult movies as a public display of its virtue is as absurd as the music industry giving its Grammy Awards to Mozart, Bach, and Verdi or international oil companies presenting awards to avant-garde artists who happen to paint in crude. While Hollywood studios, or their wholly owned—independent—subsidiaries, occasionally make or distribute artistic and social-commentary films, their principal business is no longer about making movies. It is about creating properties—including TV programs, cartoons, videos, and games—that can serve as licensing platforms for a multitude of markets.

The confusion stems from the fact that for the first twenty years of the Academy Awards, the movie business was entirely about movies. But that was before the advent of television, in the late 1940s. The studios simply followed their audiences home. To do this, they first repackaged the movies shown at theaters Pied Piper-style by making movies that visually appealed mainly to children and teenagers and then recycled them into home products, including DVDs, TV shows, games, and toys, which, in 2008, produced some 80 percent of their revenues. In this business model, alas, art, literary, and social-commentary movies are marginalized, since they cannot be either turned into licensing franchises or used to lure huge opening-week audiences to theaters. And, as satisfying as these more artistic films may be to directors, writers, actors, and producers, they do not lend themselves to sequels, prequels, or other licensable properties. They do, however, perform one function very well: acting as decoys at Hollywood’s annual celebration of itself.

After Hollywood lost its audience to television in the 1950’s, it had to reinvent itself. If it could no
longer count on habitual moviegoers to fill theaters routinely, it would go into the business of audience-creation. The means studios found to recruit audiences for each and every movie they released was national TV advertising. The tactic that evolved by the 1990s was bombarding a target audience with very expensive thirty-second ads. For this to work, studios had to find a demographic group that was both relatively cheap to reach and who could be induced by this blitz to leave the comfort of their home to see a movie. The audience that satisfied these conditions was teenagers.

Teens have three great advantages over adults for movie studios. First, they tend to predictably cluster around the same TV programs on cable networks, such as MTV, which make them much less costly to reach than moviegoing adults who, if they watch TV at all, tend to be scattered among the most expensive programming in prime time. Second, once in multiplexes, teens tend to consume prodigious quantities of popcorn and soda, which is a powerful attraction to the theater chains that book movies for a wide opening. Third, teens buy electronic games, sports equipment, fast food, and other licensable items, which make them an appealing audience to merchandising partners
with the capability of providing the multimillion dollar “tie-in” that help publicize studio movies.

By 2009, studios had become so proficient at finding, activating, and driving the teen herd into multiplexes that over 70 percent of the audience that went to their wide-release movies were under twenty-one years old. Even though the expansion of teen programming on cable and television networks allowed the studios to zero in on their target audience, they needed, as one marketing executive at Sony told me, visuals in a thirty second ad spot that would hook male teens. The movies that filled that bill were action films laden with special effects, explosions, crashes, and mayhem. Sony learned this lesson in June 2003 when it released its action movie
Hollywood Homicide
, with Harrison Ford, a $20 million star, against Universal’s action movie
2 Fast 2 Furious
, a lower-budget film without any stars.
Hollywood Homicide
featured images of Harrison Ford in its thirty second ads, whereas
2 Fast 2 Furious
featured flaming car crashes. Even though
Hollywood Homicide
had done much better than
2 Fast 2 Furious
in the pre-openings awareness polls,
2 Fast 2 Furious
had a $50 million opening while
Hollywood Homicide
took in only $11.1 million. The Sony marketing executives could only conclude:
Teens are more excited by car crashes than by big name stars, even one who gets a $20 million dollar paycheck. It thus became as important to cast car crashes and other violent stunts as stars in the teen-oriented remake of Hollywood.