Building a Better Movie Business

The big studios effectively control distribution, which suits the cinema owners just fine (they know studios will spend heavily to advertise to get people off the couch and into the multiplex). So if you're a filmmaker and want to reach a fairly large audience and make some real money, you simply have to get a major studio as your distributor--which means giving the studio the copyright, too.

This system has been imploding for two reasons. First, it depends on mobilizing a mass audience through mass marketing, and that's a daunting task these days. It's extremely hard, and extremely costly to reach an audience fragmented by the countless options offered by cable networks, the Web, video games, and home video. That's particularly true since with each film, the studios "have to create a brand from nothing, and they don't have a lot of time to do it," says Nicholas Donatiello of Odyssey, a consultant to media and entertainment companies. (No wonder Hollywood prefers to make sequels, or buy the rights to established brands, such as Harry Potter, or fork over as much as 30% of the gross to stars such as Tom Cruise, who are their own brands.)

Second, nearly every movie loses money on its theatrical run these days. Studios typically pay as much to advertise a movie's cinematic release as they spent making the movie to begin with. They're stuck betting that much because a big-screen opening is essentially an expensive form of promotion--not only to the consumers who'll buy or rent the DVD but also to "the industry." The opening helps determine how much the studios can get for licensing the movie for pay TV, cable, and overseas. The theatrical release has become a loss leader to promote the studios' real moneymaker, the DVD, which in turn often serves as a loss leader for Wal-Mart to draw in shoppers.

Talk about a badly convoluted system. Hollywood's moguls know they're in big trouble when the single most powerful person in the industry today is Wal-Mart CEO H. Lee Scott Jr. Don't you think DreamWorks Animation CEO Jeffrey Katzenberg would rather hang out at a beach house in Malibu with Steven Spielberg than schlep to Bentonville, Arkansas, for the retailer's Saturday-morning management meetings? But schlep to Bentonville he does--often, actually--and he even wears a blue Wal-Mart apron when he's there.

If today's problem for the studio moguls is that they're captives of Wal-Mart, then tomorrow's will come when they're challenged by the likes of Google, which has declared itself a "media company," and Yahoo, which is paying $100 million to take over the huge former MGM headquarters in Santa Monica, California, as offices for 1,000 employees in its Hollywood division. Yahoo's operation is being run by Lloyd Braun, a former ABC executive who helped oversee the creation of Desperate Housewives. His mission is to create original, interactive programming that reinvents news and entertainment for a new medium. He has already hired his own roving war correspondent, Kevin Sites, and set up an "adventure" channel on which mountain climbers, for example, will post their own videos.

The Internet's immediate threats to the Hollywood oligarchy are piracy, which costs the industry some $5.4 billion a year, and competition, in the form of digital blandishments that are drawing more and more people out of movie theaters. (Box-office admissions fell some 12% this past summer; the defections were even more dire among the movies' prime market: young males.) But the real threat is how the digital lifestyle has radically changed consumers' expectations. What we have learned from the first decade of the digital era is that we're the ones who will be in control of when, where, and how we consume media. Give us cell phones, and we'll tear out our landlines. Give us laptops, and we'll chuck our desktops. Give us Wi-Fi, and we'll take our laptops everywhere. Give us BlackBerrys, and we'll leave our laptops at home. Let us download music, and we'll never go to the store to buy CDs. Give us VCRs and TiVo, and we'll watch TV shows whenever we want--and zap the commercials. Give us the news as it happens, and we won't look at tomorrow's papers.

Hollywood's movie and TV businesses are the last part of the media-entertainment complex to confront this empowered digital consumer. That's because good-quality video takes up so many more bytes than text, graphics, and music--making it slower to transmit and harder to store. To date, the digital boom has mainly benefited Hollywood: Many of the top-grossing films of recent years have either been digitally animated (Shrek 2, Finding Nemo) or relied heavily on digital special effects (the Lord of the Rings trilogy, the Star Wars prequels). And high-definition digital production is letting filmmakers such as Robert Rodriguez and Steven Soderbergh create movies for a fraction of traditional budgets.