Entertainment Marketing

Professor Phillip Cartwright

Paris School of Business EMBA

Entertainment and Media:

Markets and Economics II*

*Acknowledgement to Professor William Green – New York University

 2/34

Production and Cost

· Economic Foundations
· Production Functions
· Costs of Production
· Economies of Scale and Scope
· Technological Change
· Features of Entertainment and Media Firms
 4/34

Caves on Creative Industries

 Characteristics of Production in Creative Industries
– Uncertainty of Demand
– Producers’ emotional connection to the output
– Assembly of diverse skills for production (movies, sports)
– Differentiated products
– Vertically differentiated (ranked) skills
– The role of time in consumption
– Durable products and durable rent streams
 5/34

The Production Function

· Output
· Inputs – The factors of production
· The “process”
Labor
Capital
?
Materials
 6/34

About Production Functions

· Factors and Factor Intensity
· Higher education
· Broadway theater – labor intensive
· Major League Baseball - ???
· Casino – capital intensive
· Substitution of Factors
· Live theater
· Movies
· Others?
 7/34

Features of Production Functions

· Managing a multiplex – Two outputs

· Concessions (the primary source of profits)
· Movies (the secondary profit center)
· Casino
· Making movies (indies vs. studios)
· Professional sports performance
· Delivery of professional sports
· Music
· Publishing
 8/34

Multistage Production Is
Common
Financial Services Professional Sports Publishing

Back office Team sports Author

Large scale Advertising and Publisher

content assembly

Retail banking Broadcast to homes Retail distribution

And, of course, … Movies and Television

 9/34

Multiple Stages in Production

The TV
The game broadcast
The viewer
Players
TV
Capital F(x) F(x)
Equipment
Sports
Capital
Equipment
Labor

What’s better for this process, one firm or two?

 10/34

Features of Entertainment and

Media
· Stages of production
· Outputs as downstream inputs
· Content creation
· Labor intensive
· Little substitution
· Less Technologically Oriented
· ***** Animation is a MAJOR exception
· Delivery – Exhibition, distribution
· Capital intensive
· Technological advance
· Applications: Books, Movies, TV, Newspapers, Radio,
Recorded Music
 11/34

Live Performance Production

 Production Function – One “Stage”
 Simultaneous Production and Consumption
 Feedback Between Consumers and
Producers
– Concerts
– Big Sports
– eBay
 12/34

The Costs of Production

· Fixed cost: Not a function of output. Capital
· Sunk cost: One time, nonrecoverable costs
· (very significant in the movie business)
· Variable cost: Variable with respect to output
· Labor
· Materials
· Marginal cost: Avoidable cost of one more (less)
unit
 15/34

Terminator 3
Production $100m
Marketing 85m Actual:
(WB=50m, Sony=35m) U.S. Box Office: $150.4M
Austrian actor 29.25mWorld incl. US: $ 417.3M
(#113 all time – on a list that does not
Rights: WB 50m correct for inflation, currency, or
anything else.)

Sony 75m
Profit anticipated (WB) 25m
http://www.edwardjayepstein.com/x-rar1.htm
 16/34

Cost and Revenue Trends

 2002-2004: Revenue growth from $115M to $130M

 2002-2004: Cost growth from $111M to $130M
– 65% due to production and marketing
– 20% rising home video manufacturing costs
– 15% due to higher “talent participation”
Changing Economics for Stars
 2005: $10M, $15M, $20M, …
 2010:
– Small or no up front (except for Angelina Jolie)
– CB 0 contract (Cash-Break zero – percentage
after break even)
– Far smaller total compensation for start
 Why?
– Economics of film making
– Falling demand for star power in movies
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17/34
 18/34

Economies of Scale
· Working definition: Declining average cost
· Market based definition: Competitive advantage
of large size
· Sources
· Supply based: Technical,
· Demand based: Networks
· Indivisibilities: Lumpiness
 19/34

Economies of Scale in E&M

· Cablevision
· Professional sports
· Publishing/Movies – Backlists of titles
· Casinos
· Movies
· Television
 20/34

Economies of Scope
· Cost effect
· C(Q1,Q2) < C(Q1,0) + C(0,Q2)
· Not the effect behind vertical integration
· News media owning the sports team? (Murdoch and
Manchester)
· Applications
· Cable TV, Internet
· Mobile phone network
· Basketball, Hockey
 21/34

Technological Advance
Average total cost

t1
t2
t3

Output

Cost Reduction
Digital setup in newspapers
Synthesized instruments in Broadway Musical Orchestras
 22/34

Digitizing Entertainment – Technical

Advance in Delivery of Existing Forms
· Music
· MP3 - affects distribution, not creation
· Pop music without musicians.
· Literature:
· E-books – Kindle (Amazon), Nook (B&N)
· E-zines (Slate.com)
· Web based news services (NYTimes.com)
· Movies:
· Creation – digital equipment, Pixar animation
· Distribution – transmission without film
· Exhibition – digital projection (expensive)
 23/34

Labor Saving Technological

Change
Now, after 500
performances, our
producers have told us
and our union that in order
to cut costs they will chop
our string section in half,
releasing five musicians
and “replacing” them with
a synthesizer piped in
from another room.
NYT, OpEd, 7/10/10
 24/34

“Book” Production Costs

 25/34

Who should bear the cost?

(About $100,000/screen)
Film makers?
Distributors?
Equipment makers?
 26/34

3D - The Next New Thing

2D Format: Existing projecting systems; 20 new
movies in 2008-2010.
3D Format: About 1000 existing projection systems
plus 250 IMAX. Requires digital projection.
“It’s not always as good as they say it is…”
“I’m not so sure our customers even know we have
it…” Theater owner, New Mexico.
Can it be priced? Maybe. Hanna Montana
tickets sold (box office) for twice the usual price.
Was it the 3D or was it Miley Cyrus?
 27 /34

3D Economics
 30 3D Movies
– “Avatar” - $250M
– Benefit: Net addition to profit $80M (Dreamworks)
 Obstacle: Digital Projection
– Insufficient screens (3000 needed for an opening)
– Uncertain financing for theater digital projection
(financial crisis)
– Pricing the Upgrade ($25 tickets)

http://www.nytimes.com/2009/01/12/business/media/12film.html?_r=1&scp=2&sq=3D%20+%20%22Coming%20at%20You%22&st=cse
 42/46

Markets for Experience Goods

 Demand is different
 Supply and costs are often similar but often very different (books
vs. concerts)
 Economies of scale and scope, technological change, etc.
 Complex interdependencies in markets
 Market structures do not mirror the rest of the economy (large
pockets of “rent”)
 Demand interdependencies
 Complex contractual arrangements
 Vertical integration
 …
 34/34

Entertainment and Media: Markets

and Economics

End Class 2 – Part 1

 2/42

Agenda
 Setting a Price
 Economic Rent and Capitalization
 Profits and Losses
 Monopoly, Monopsony, and the Reserve
Clause
 3/42

Entertainment
and Media:
Markets and
Economics
Economic Rent
 4/42

Setting a Price – How To?

 Car
 Amazon.com – Econometric Analysis
 Restaurant – A Meal
 Software Vendor – Online Distribution
 Royalty Holder – Price for an advertiser who uses
your jingle or tune
 Major League Baseball – How much for a license to
use the statistics. (Players Union: How was the $50M
price for the rights to their celebrity set?)
 5/42

Economic Rent
Market value in excess of the value of the next best
alternative (opportunity value)

Resource Activity Foregone Economic Rent

Dr. Cartwright Professor Consultant Approximately zero

“Old” gas well Natural gas None Price – MC

Tom Cruise Actor Race car driver 20,000,000 (Still ?) –

20,000
Alex Rodriguez Baseball player ???? 20,000,000 - ?000
 6/42

Doug Glanville’s Economic

Rent

“One superagent took the time to explain why I should ask for three times
the market rate for my signing bonus. He made the compelling argument
that since I would be forgoing the use of an Ivy League engineering degree,
the team that chose me should compensate me for my lost wages. He
made it clear that the sum of this compensation and a little extra should
make up my total bonus.” (“Doubleday and Darwin,” by Doug Glanville,
NYT, 7/5/2008)
 7/42

Sources of Economic Rent

 Natural endowment
 Creation of something of value to a market
+ property right (ownership)
 Positioning and market disequilibrium
 Creation (or exploitation) of a market
failure (apartment brokers in New York)
 8/42

Entertainment
and Media:
Markets and
Economics
Valuation
 9/42

Valuation – Capitalization of
the Stream of Economic Rents
 Stream of benefits
 Discounted present value
 Equivalence of stream and DPV
 Valuation: A share of stock
 10/42

Applications of Valuation
 The dot com gold rush
 Bubble?
 Option value under uncertainty
 Capitalized values of future profits
 TV sports broadcasting
 Valuing a movie
 Baseball
 Valuing the team
 Rodriguez ($254m), Ramirez ($180m), Jeter ($189m)
 Valuing a painting, a violin – how do these differ?
 Employing a well known
theorem:
$240M/0.016 = $15.0B

www.msnbc.com/id/21458486/
 12/42

http://www.techcrunch.com/2006/10/09/google-has-acquired-youtube/
 13/42

http://money.cnn.com/2008/02/01/technology/microsoft_yahoo/index.htm?cnn=yes
 14/42
Baseball Values
2008 2009

http://www.forbes.com/lists/2009/33/baseball-values-09_The-Business-Of-Baseball_Value.html
http://www.forbes.com/lists/2008/33/biz_baseball08_The-Business-Of-Baseball_Rank.html
 Realized Market Valuation

http://www.nytimes.com/2010/08/06/sports/baseball/06rangers.html
 15/42

Basketball
2009
National Football League (2009)
MLB vs. NFL (2009)
NHL (2009)
World Football
 19/42

Entertainment
and Media:
Markets and
Economics
Profit
 20/42

Capturing Economic Rent

 Market processes
 Freelance market
 Agents (What do agents do?)
 Sports
 Literature
 Performers
 Vertical integration
 The reserve clause
 The studio/star system
 21/42

Profits…
 Gross Revenue Minus Total Cost
 Cost includes the cost of capital
 Ambiguities in the allocation of cost
 Ambiguities in the resolution of claims to
the net
 Contractual arrangements
 22/42

Profits and Losses

Simple Cases: Electronic Commerce

Average Total Cost

Amazon
Average Variable Cost
EToys
Average Fixed Cost

Amazon: P > AVC, P < ATC

EToys: P < AVC (RIP, April 6, 2001)
 23/42

Profits in Multiple Output Processes

 Allocation of revenues to activities

 Multiple revenue sources (outputs)
 Allocation of costs to activities
 Fixed costs in multiple output firms

A Miami Fish Story

 24/42

Accounting Issues
 Complications in the Miami Fish Story
 The source of franchise value
 Tracing revenue to activity
 Activity based costing
 Economic profits
 What if the stadium has other uses? (Britney)
 Arizona Diamondbacks?
 Other applications?
 25/42

Profits in Multistage
Processes
 Allocation of net revenues to activities
 Revenue stream arrives at the end of the
chain
 Allocation of revenue streams to activities
in the chain – essentially transfer pricing
 Net vs. gross in Hollywood
 26/42

Profits in the Movies

Gross Box Office

Production Distribution Exhibition

There is no net! 30-50%

Net

Sharing rules: Some participants (usually actors,

e.g., Tom (Gump) Hanks) and directors get a % of
gross distribution revenue.
 27/42

There is No Net
 Forrest Gump (1994) (Paramount Pictures)
– US Box Office $330M
– Foreign Box Office $350M Total, About $830M
– Soundtracks, etc. $150M
– Net profit -$ 62M (!) A disappearing act?
– U.S. Box  50% to Exhibitors (Theaters)
– Paramount Receives Approx $191M
 Distribution “Fee” = 32% $ 62M
 Distribution Cost $ 67M (Advt., Prints, Screening, etc.)
 Advt. Overhead $ 7M (10% of Distribution Cost)
 Production “Negative” Cost $112M
• (Tom Hanks, Robert Zemekis, $20M (8% of GROSS, each)
• Studio Overhead $15M
• Interest on Negative Costs $ 6M
– Net Profits from the Project -$62M
– Winston Groom, Author 19% of NET = 0
– Eric Roth, Screenwriter 19% of NET = 0
 28/42

Hannibal: Who Ate the

Profits?
 Gross B.O. as of 3/19/01 = $250M, expect $400M
 Exhibitors: 30%, leaving $175M to divide
 Partners: Dino De Laurentis, Universal, MGM, Anthony
Hopkins, Thomas Harris (author), Ridley Scott (director):
34% (DDL, 10%), apx $60M
 (Jodie Foster wanted $20M + 15%, or $80M)
 Prod’n and Promotion approximately $80M
 Remaining $40M goes to studios, etc.
 29/42

“Revolution?”
 An optimistic accounting (Tomcats):[Actual=$100M Box Office]
 Costs = $105M
 Production = $40M [Sony(20), Revolution(7), Senator(6), Fox(5), Pony
Canyon (2)]
 Print and Promotion = $65M [Sony (58; U.S., foreign), Toho Towa(4, Japan
Mktg.), Senator(3, Germany Mktg.)
 Revenue = $340M
 Domestic box office 100
 Overseas box office 100
 Worldwide TV 80
 Worldwide home video 60
 30/42

Distributing the Joe Roth “Net”

 Recoupable production and marketing 105
 Theater operators 100
 Residuals and third parties (investors) 25
 Distribution fee to Sony (U.S., Int’l) 20
 Video duplication 15
 Distribution fee to Senator (Germany) 3
 Distribution fee to Toho Towa 2
 Distribution fee to Pony Canyon 0.5
 Net to Revolution 72
[Joe Roth(42), Equity investors (18), Other executives (10.8)
 IS THIS A GREAT BUSINESS OR WHAT???????
 31/42

Mona Lisa Smile

Date Rank   Gross $ % Change Theaters Per Theater Total Gross Days

12/19/03 2    11,528,498   2,677 $4,306 11,528,498 3

12/26/03 6    11,351,439 -1.54% 2,677 $4,240 31,226,270 10

1/2/04 7    8,300,794 -26.87% 2,714 $3,059 50,006,766 17

1/9/04 10    4,383,072 -47.20% 2,500 $1,753 56,883,304 24

1/16/04 15    2,138,100 -51.22% 1,836 $1,165 60,498,345 31

1/23/04 19    888,179 -58.46% 1,007 $882 62,351,962 38

1/30/04 27    306,953 -65.44% 440 $698 62,964,117 45

2/6/04 38    120,760 -60.66% 154 $784 63,177,379 52

2/13/04 33    219,815 +82.03% 278 $791 63,442,925 59

2/20/04 37    145,824 -33.66% 235 $621 63,695,760 66

2/27/04 52    $60,170 -58.74% 117 $514 63,803,100 73

Will this movie ever ‘make money?’

 32/42

(Bennifer) Gigli
Weeknd Gross % Change Theaters Average Gross-to-Date Week #
Aug 1–3 $3,753,518 2,215 $1,694 $3,753,518 1
Aug 8–10 $ 678,640 -81.9% 2,215 $ 306 $4,432,158 2
Aug 15–17 $ 18,702 -97.2% 2,142 $ 256 $4,450,860 3
Overall… $5,600,000 (apx)
(That’s all folks…..)

Costs? Bennifer $25,000,000

Other $29,000,000
Promotion $22,000,000
Distribution ?
Did this film ‘make money?’ Can it?
No Theory Explains Delgo

Delgo is a 2008 computer-animated fantasy

film. The film was produced by Fathom Studios,
a division of Macquarium Intelligent
Communications, which began development of
the project in 1999.
Delgo grossed just $694,782 in theatres against
an estimated budget of $40 million, according to
box office tracking site boxofficemojo.com. The
film was released independently with a large
screen count (over 2100 screens).
 33/42

Garrison v. Warner Bros (1995)

 Who was Jim Garrison?
 “On the trail of the Assassins (of JFK. Oliver
Stone et al.)
 Class action on behalf of “talent”
 Defendant: Every movie studio plus various
unnamed coconspirators.
 “There is no net”
 See www.courttv.com/legaldocs/business/garrison.html
 34/42

Entertainment
and Media:
Markets and
Economics
Market Outcomes:
Monopoly and
Monopsony
 35/42

Monopoly and Monopsony

 Monopoly
 Monopsony
 Equilibrium and Disequilibrium
 Change and Opportunity (The Theater
Business – Matt Heyman and CineMex)
 36/42

Monopolistic Competition
 Model for publishing
Average total cost
 Distinct monopoly
This monopoly
power, indistinct profit disappears.

rates of return.
 Rents are dissipated
Marginal cost
at earlier stages
MR Demand
in the production
chain.
 Applications?
 37/42

Sources of Monopoly Profits

 Sources of monopoly
 Rockefeller’s oil empire
 Microsoft
 How do these differ?
 Where do the economic profits reside?
 The music industry
 The movie business
 Broadcasting
 38/42

Monopoly Market Segments

 Monopoly in the EMT Economy
 Publishing
Where are the
 Movies
“pockets” of market
 Newspapers power, if any, in the
 Television production chains of
 Professional Sports these markets?
 Casino Gambling
 Rent seeking activity in multistage markets
 39/42

Monopsony
Movie stars, shortstops, late night talk show hosts, perky
morning news personalities
Marginal expense on players

Supply of players
Value

Wage Marginal value of players

The source of the Yankees’

Number hired $190M payroll – A-Rod 
Jeter, Giambi, etc.
 40/42

Monopsony Applications
 Major League Baseball – A Strategy for Using
Monopsony Power
 Cartel – enjoyed supreme court approval
 Reserve clause’s demise (Curt Flood, Catfish Hunter,
Andy Messersmith)
 Movie Studios and the Star System
 Illegal cartel
 Largely became obsolete and irrelevant
 Fashion Models (Ford, etc.) … whoops! Who
knew the antitrust laws applied to us too?
 41/42

Bilateral Monopoly
 Competition for economic rent
 Baseball
 Arbitration
 Free agency
 Movies
 Stars as free lancer
 Stars taking equity stakes in movies
 Music: (ASCAP/BMI) v.
(AOL/Yahoo/Real)
 43/42

Entertainment and Media: Markets

and Economics

End Class 5 – Part 2