Economics of the movie business Essay

Most of the movies that are eventually released are cofinanced. This is a term that is used within the movie industry to describe those films for which there are more than one firm that share both the cost of production as well as the revenues. Nearly one-third of all the movies that are released are cofinanced. Various studies have shown that the main reason for cofinancing is to manage and share risk. Most of the major studios are in the category of publicly traded firms where the investors are free to carry out their own diversification decisions. Not always is the cofinancing decision related to the movie returns as the studios rarely cofinance highly risky films1. Demand is difficult to predict and thus financial risk remains to be a characteristic of the film industry since most of the cost is incurred long before the demand can be actualized. It’s thus the reason that most of the authors in this field have argued that the key variable that shapes the industry is the financing strategy adopted. Mainly, there are three ways in which cofinancing would reduce risk associated with the movie production. First, the cofinancing of the relatively risky films by the studios would give them the opportunity to participate in the less risky projects. Second, cofinancing would allow studios to fine tune their portfolios thus gaining the advantage of covariances of the gains across the movies. The third advantage of cofinancing is the simple law of large numbers to share a potential loss . Data collection The data to be used here in this paper is the information provided forth in Goettler, R. L and Leslie, P. (2004) where information on over 3,826 movies was exhibited in the US between 1987 to 2000. The primary source of the data was the Internet Movie Database (IMDb). The analysis focused mainly on ownership choices of the major studios. Out of the 3,826 movies examined, 1,305 were produced by the major studios. The analysis here focuses on ownership choices that have been made by the major studios. Movie profitability has been based on the return on investment, RIO, which is defined as the revenue divided by the cost. Revenue in this case was measured as the North America box office revenue and cost was obtained from the production budget. Film’s negative cost, which is the standard measure of production cost was also used. Other cost such as advertising are in most cases proportional to the cost of production and were thus not evaluated in this kind of study. Thus the ROI evaluated here was basically the relative profitability of the films but not the absolute profitability. Also the measure of revenues in this study excluded some revenues such as foreign box and video revenue. It would be ideal to use all the revenue sources but the approach would have limited the number of films in the analysis as most of this kind of data is only available only to a subset of films. At the same time limiting the analysis only to the films with this kind of extra data may introduce selection bias as most of this data maybe limited to the successful films only1. Identification of cofinanced films The listing of a production company is the first sign that there are cofinancing partners but this is not a sufficient condition. The most important criteria is to know if a firm contributes towards the production cost. Its worth to note that a firm can be credited for having contributed into the production company of a film after initiating then selling the project to a major studio even without retaining revenue shares. This kind of arrangement referred to as â€Å"first-look deal† is common between a semi-independent production company and a studio in a long-term relationship. The criteria used here in determining if a film is cofinanced is that first if a major studio is on the list of the production company for a certain film, then the assumption is that the studio has some ownership stake in the film. Second, Variety magazine was a source of those firms with the first-look deals from the â€Å"Facts on Pacts† list and those that are equity partners. The assumption here was that a firm was a joint owner if it was on the production company list and also on the equity partner2. For those movie that an independent firm and a major studio cofinanced, the question of whether either of these two had the option of being sole-owner remains. In simple term, one may also question which among the two firms initiated the entire project? The available information suggest that the studio usually has the mandate to decide if it will co-own or just be a sole-owner. This kind of decision called â€Å"greenlighting† is usually made during decision point of whether to make the movie or not. Complications do arise like when two companies have the same subsidiary structure such as having the same parent company and at the same time end up owning the same movie. In such cases, it was assumed that the movie was not cofinanced since the production divisions happen to work as integrated components of the parent studio rather than as being competitors. Another point of ownership ignored was the cases where the directors or the star actors negotiate a part of the movie revenues. This was so because most of this happens as a result of the directors/actors strong bargaining power to have a share of the revenue once the movie is successful rather than a strong will to share and manage risk.