The Hollywood Economist (15 page)

Even though most of the other major studios did not participate, the DVD roll-out succeeded in transforming films into a retail product. DVDs could be played not only on DVD players, but on personal computers, game consoles, iPods, and other digital devices. By 2000, Wal-Mart had become Hollywood’s single biggest customer, selling about a third of all DVDs, occasioning top studio executives to journey to Bentonville, Arkansas, to find out what ratings, stars, genres, and other attributes would help them win strategic placement in Wal-Mart stores.

Throughout the 1990s studios had been cutting back on the number of titles they released
since the popcorn culture at the multiplexes did not require much diversity. But now retailers such as Wal-Mart, Target, and Borders allocated valuable shelf space according to the numbers of titles a studio could deliver. As shelf space became the new name of the game, studios sought to increase their leverage, or throw weight, by buying up independent distributors (and later “mini-majors”) to get more titles. As a result, six companies—Time Warner, Sony, Fox, Viacom, Disney, and Universal—came to dominate not only all the major releases but the entire universe of so-called indie releases. The DVD, with its random access and easy navigation, also opened up for these companies a rich new market: boxed sets of TV series. Not only could they tap their huge TV libraries, but they could invest in original series, such as
The Sopranos, Mad Men, Big Love, The Wire, Rome, Dexter, Sex and the City
, and
24
, which often proved more profitable than films that opened in theaters.

For the growing home audience, the DVD also made films a more interactive experience. Couch potatoes could now change the language of a film, its aspect ratio, rating, or ending; watch additional scenes (which in some cases are shot for the DVD), or listen to commentaries by directors, writers, and actors, or play a game, music video, or gag reel. With these bonus features
driving a large part of DVD sales—one-third of polled DVD buyers said that they first played the bonus feature—Hollywood’s films became part of a package.

The next move by the Japanese electronic giants came in 2005: the high-definition disc. Pioneered by Japanese television in the late 1970s, high definition makes the home the equivalent of a theater by furnishing film-like images on a large screen. There were two versions, Toshiba’s HD-DVD and Sony’s Blu-ray.

Since both render a similar quality image, the battle between Sony and Toshiba turned on who could enroll Hollywood studios in support of their format. And, as the Japanese manufacturers knew from their past format wars, this would require bribes in the form of “replication deals.” Sony had an advantage in that it owned one of the major studios, Sony Pictures. It then bought control of MGM—almost exclusively for the purpose of locking its library into the Blu-ray formula. And it made secret deals with Disney and Fox, giving it four studios with about half of Hollywood’s desirable titles. Toshiba fought back by spending over a quarter of billion dollars in cash replication deals, getting for its money Paramount, Universal, and Dreamworks to commit to exclusively put their titles on Toshiba’s HD-DVD format. The format
war was then decided by Warner Bros., which sold almost 40 percent of all DVDs. Its new CEO, Jeff Bewkes, decided its interest lay in establishing a single format, and opted for Blu-ray.

Meanwhile, Sony launched PlayStation 3, which despite its juvenile sounding name, is a state-of-the-art computer that can connect wirelessly to TV sets, computers, printers, and the Internet, and simultaneously run up to nine different kinds of consumer electronics, play and record high-definition films, download movies from the Internet and (with a card) cable television, and, as far as games go, render characters in frighteningly realistic ways. The result is further convergence of Hollywood’s dream factory with the digital domain.

The hand of Tokyo may not always be visible in the dazzling glitter of Hollywood, but it has enabled it to re-invent itself. It is not that the Japanese set out to change the way the world sees movies, it is that Hollywood failed to see its own digital destiny.

Up until 2007, the studio’s principal access to the home market came through pay-TV, free television, video rentals, and DVD sales. But now, with
products such as Apple’s video iPod and TiVo-type digital recorders becoming widely available, Hollywood is inching towards an even more lucrative way of exploiting the home market.

Disney’s ABC network, for example, made a deal with Apple that will allow iPod users to download and watch shows for $1.99 an episode. The other networks, CBS, which is still controlled by Sumner Redstone, and NBC, a subsidiary of NBC Universal, are selling their programs for 99 cents a viewing via linkups with cable and satellite providers.

This downloading strategy is particularly appealing to the broadcast networks because, unlike cable networks, broadcast networks presently get no cash compensation from cable operators. (At best, cable operators might agree to carrying their new cable networks.) But by offering their hit programs for downloading the next day, networks get cash from the cable audience. A cost of 99 cents a pop is hardly trivial when multiplied by a cable audience of thirty or so million. The downside is that they may lose part of their regular TV viewers, and the advertising revue that goes with their loyalty. But the networks are betting that their regular audience, which can watch the programs free, would have little incentive to wait a day and download them for a fee. Even Netflix, which has been enormously successful using the mail to deliver
rental DVDs for a monthly fee, has now created an online delivery system to replace trips to the post office.

The studios stand to gain even more from a huge audience willing to pay to download movies from their libraries. Unlike DVDs or Blu-rays, which require manufacturing, warehousing, distribution, and disposing of returns, it costs almost nothing to download a movie or cartoon. Indeed, all of the costs of transmission would be borne by the cable operator (or a site like the Apple iTunes Store), whose cut would be less, under present arrangements, than retailers get on DVDs. So if a movie were a huge hit, such as
Shrek
, and millions of orders flooded in, the marginal cost of filling them would be near zero. The consumer, once he bought the download, could watch it where and when he chose to, just as he once watched a DVD.

The real issue for the Hollywood studios is how they can dig into this potential gold mine without undermining their existing revenue streams.

With the possibility of costlessly providing millions of downloads to consumers of both their older and new films, the studio heads, including Disney’s Robert Iger, are openly discussing a radical revamping of the window system. Obviously,
if a home download of a movie were available at the same time (and price) as its DVD release, the download option might replace retail sales. To avoid that outcome, and a potentially dangerous confrontation with Wal-Mart, the studios would have to delay the download release until well after the DVD release. But while the studios may find this embarrassment of choices somewhat paralyzing at present, as more and more consumers get digital recorders or video iPods, downloading for dollars may prove irresistible.

Hollywood has spent the better part of the last century making movies out of the great inspirational sagas of human history. Ironically, the one epic it has yet to make is one about a uniquely American achievement that has and continues to mesmerize the world: The Rise of Hollywood. Here is a true
Sturm und Drang
melodrama, full of fascinating characters from the edges who overcome seemingly impossible obstacles to build a
new industry that today defines the world of mass entertainment. The scenario would follow the classic Hollywood three-act formula.

Fade in on the men who founded the studios of Hollywood. These are self-made and self-educated Jewish immigrants from European ghettoes, who, before they got into the movie business, had been ragpickers, furriers, errand boys, butchers, and junk peddlers. They are true outliers: men like Louis B. Mayer, Samuel Goldwyn, Jack Warner, Adolph Zucker, William Fox, Carl Laemmle, and Harry Cohn, who first scraped together money to build arcades and nickelodeons to show movies, then resourcefully expanded into theater circuits, using bicyclists to deliver reels between their theaters. As movies become a national craze, they build distribution networks to service other exhibitors, and then studios to assure that they have enough movies. Along the way, they battle part of the establishment in the form of the powerful Edison Trust, which, aside from its patents on electricity generation, holds numerous patents on movie cameras and projectors. When “the Trust,” as it is ominously known, attempts to use the courts in New York and Massachusetts to take
over the movie business, the movie-makers move their studios to the newly incorporated village of Hollywood, a place they can control and build. By the mid-1920s, 57 million people—over half the population—are going to their movies every week. Yet the saga is just beginning. In 1927, sound comes to the movies. After audiences are mesmerized by Al Jolson in
The Jazz Singer
, Hollywood, in one of the great technological feats of modern history, converts most of the 21,000 movie theaters in America to sound and turns their studios into sound stages. The studios create new galaxies of stars for their talkie movies. Despite even the great depression of the 1930s, the weekly audience grows to 75 million, who go to their neighborhood theaters not just to see feature movies, but newsreels, comedy shorts, action-packed serials, and cartoons. A new generation of talent, including such brilliant innovators as Walt Disney, expands its realm to children’s entertainment, and color adds to its ability to entertain the public even in the bleak years of the Depression and the grim war years of the early 1940s.

The Second World War has ended, the troops have come home. By 1948, the studio system is at its zenith.
More than 90 million Americans—two-thirds of the population—go to the movies on a weekly basis. The studios produce more than 500 feature movies per year, have all the major stars under ironclad contract, and employ more than 320,000 people. Their illusion-making technology is unmatched anywhere in the world. In little more than a generation, its founders have literally gone from rags to riches. The studio heads, now called “moguls” after Oriental potentates, are among the highest-paid executives in the world.

But a new invention is casting an ever-darkening cloud: television. Even with its fuzzy black-and-white pictures, it offers nearly free stay-at-home entertainment, which gradually captures a larger and larger portion of the studios’ habitual audience. In addition, a long-simmering antitrust action severs the studios’ hold on American theaters. According to the consent decree they sign, they must divest themselves of the theaters they own and give up their practice of forcing independently owned theaters to book an entire package of movies if they want any at all. The final blow to the studio system comes when stars, at the behest of their newly empowered agents, refuse to sign long-term contracts. The moguls now have to compete with independent and foreign producers for both theater bookings and stars.

After color TV is introduced in the 1950s, the movies’ weekly audience goes into free fall. By 1958, it is less than half the size of the 1948 audience. Drive-ins, Cinemascope, 3-D, Surround Sound, and other innovations fail to win back the audience from television. The entertainment landscape in America has changed, and reflecting this change, the stock prices of studios plummet to levels not seen since the Great Depression. Prophets of doom predict that the end of Hollywood is near.

However, the prophets have underestimated Hollywood’s resourcefulness. For a half-century, its genius has been its ability to adapt to new circumstances. It is, after all, in the business of entertaining mass audiences, and those audiences, though diverted, have not vanished. So Hollywood reinvents itself. The old studio system, with its contractual control of theaters and stars, is dead; long live the new studio system. Unable to depend on a habitual weekly audience that has defected to television, it turns television to its own advantage by using national TV advertising to create tailor-made audiences for each and every movie. It greatly expands its reach overseas, creating
a second stream of revenue from theaters and television abroad.

Nor does the new Hollywood limit itself to theaters. It finds new sources of revenue in licensing its movies to television, originating prime-time series, renting its movies on home video, putting them on planes and in hotels, reincarnating their characters as toys, and then, with the digital revolution, putting its movies on DVDs, Blu-ray discs, video-on-demand, cell phones, and the Internet. Since networks are restricted by a Federal Communication Commission rule from having a financial interest in their programming, the studios become the main suppliers of prime-time television (which they could later sell to local stations). This expansion not only keeps the movie business alive, it makes it central to the world’s entertainment economy. But beyond the movies, the money, and the job creation, Hollywood produces another form of wealth: the pictures in our head by which the world at large defines the phenomenon of American culture. What a movie that achievement would make.

“Dear Hollywood Economist,” an anonymous producer based in Paris wrote me on my website in
December 2009. “I am trying to raise $20 million through pre-sales for my next movie. So far I have had no success. A former Miramax executive, who is now in the business herself of arranging financing for independent movies, told me ‘the indie business is all but dead.’ Is she right?”