Box office profitability mixed with homevid decline changes equation

Is it coincidence, or is it the start of a movement?

In recent weeks two high-profile execs have argued publicly for an improbable scenario: The studios would be better off if they got back into the theater business.

First, at a Variety confab on May 3rd, Joe Roth called for a lifting of legal restrictions on studio ownership of moviehouses. Then, at the PGA’s Produced By conference June 5, Mark Cuban said the majors would benefit if they bought theater chains.

Cuban’s remarks echoed his statement in a May 23 email to Variety responding to a request to comment on what Roth had said. “Joe is absolutely right,” he wrote. “Being vertically integrated would allow a large organization to optimize how and where it releases content.”

Of course, vertical integration is what the Supreme Court outlawed in 1948 when it forced the studios to divest themselves of their theater chains. Those restrictions were somewhat eased in the 1980s.

“In 1948, you didn’t have TV,” says Candace Carlo, head of the entertainment department at law firm Greenberg Glusker. “For entertainment you went to a movie theater, and the motion picture studios controlled everything. But then the marketplace changed dramatically.”

But despite some smaller initiatives in the Reagan years and a smattering of minor interests today (see chart), the studios never got back into the theater business in a serious way — probably because they didn’t see any need to rock the boat as long as they kept growing.

And grow they did, because even if box office revenues often traveled a bumpy road, home entertainment coin started rising rapidly in the 1980s and continued its upward trajectory until now. After a couple of fat decades, the majors currently face a lean period of unpredictable length due to a shrinking DVD market and the disruption of digital technology.

For Roth, the solution is to regain control over sequential distribution.

“You need to manage the way you present your product in the first window,” he told Variety. “You need to control that experience, and the only way that happens is if you own theaters.”

Control of the theatrical window, Roth says, is critical, because the second window — home entertainment — is not just shrinking, it’s under siege. In some markets like Korea, distribution coin via physical media has been decimated by piracy; plus, there and elsewhere content is moving to the Internet, where the studios have yet to find a satisfactory business model.

“Technology is not the enemy, it’s the oncoming onslaught,” Roth says. “You need to use the first window to make as much of an event of your movie as possible, to be able to determine how long a film will play and how it will be promoted.” Otherwise studios are at the mercy of theater owners who — understandably — care more about their own bottom lines than about their suppliers’ long-term interests.

While execs from the majors wouldn’t comment for this article, a former studio topper told Variety, “I agree with Joe 100%. If you have a film that didn’t open well even though it’s good, often it’s yanked off the screen and doesn’t have time to grow. If you own theaters, you can sit with it until the audience catches up.”

While owning theaters might help studios better control the promotion surrounding a film’s opening, at least in their own venues, it would — more importantly — also allow them to control the length of the theatrical window in those same theaters. Roth himself faced an exhibitor revolt over “Alice in Wonderland,” on which he was a producer, when European theater owners threatened to boycott the pic because Disney wanted to shorten the theatrical window and speed its release into the home market.

“It’s symbolic of what’s in store in the future,” Roth says. “I think we’re just at the beginning of such skirmishes.”

“The likely shortening of theatrical exhibition windows is troubling to theater owners,” says Loyola Law School professor Jay Dougherty, who nevertheless agrees with Roth that “some of these transitionalchallenges would be more easily managed if studios controlled both distribution and exhibition.”

Dougherty believes, however, that an attempt by the studios to return to the theater business would stir up legal issues. “I think the government would keep a close eye on re-acquisition of substantial numbers of exhibitors, especially if it looks like the consumer is taking a hit,” he says. “The price of 3D admissions is already a substantial premium, and if distributors paid high prices for exhibitors, there would be even more pressure to raise prices to recoup their investment.”

Like the studios, theater owners declined to comment. Said one person close to the exhibition biz: “I don’t think the majors are planning to get into this business, because they’ve all signed agreements to guarantee payment of virtual print fees to exhibitors to help subsidize the transition to digital cinema. If their thinking was to buy theaters and do this directly, why would they have gone through the hassle of setting up this very involved system in the first place?”

Others find a more fundamental flaw with the concept. “If movie studios started owning theaters again, they would find it difficult to deal with content from other studios,” says Richard Greenfield, analyst at BTIG. “Those negotiations would become very challenged.”

“Exhibition is not the studios’ business,” adds Michael Karagosian, president of industry consultancy MKPE Consulting. “Say Sony owns theaters. If Disney wants to show there, it would end up negotiating with Sony over percentage of box office; it could become nightmarish.”

Adds former studio exec Bill Mechanic: “If you own theaters, you have to worry about two businesses, not one.” The real solution to declining revenues, says Mechanic, who now heads his own shingle, Pandemonium, is to make better films. “If you make a crummy movie that you can’t expect people to buy more than one time, then shame on you.”

But if theater ownership won’t work for the majors, it can be the ticket to success for an entrepreneurial outfit like Cuban’s, which owns Landmark Theaters, Magnolia Prods., Magnolia Home Entertainment, HDNet and HDNet Movies. “Being vertical has made us smarter and more profitable” Cuban says. “We know which movies play best in which Landmark theater, which movies work best in day-and-date release and in pre-theatrical release to VOD.”

The majors won’t comment on Cuban’s vertical integration, but the fact remains that they exercise little control over that first distribution window — which happens to be showing solid revenue growth. They’re also unable to extract more than a 50% return from that window, since exhibs skim about half the cut.

“If studios owned theaters, they’d get whatever the profit was,” Roth says. “They’d keep everything. All they’d need to do is pay the rent.”

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