Rolling up the red carpet

With the award season in full flow, is the film industry really in good shape?
Commercial awareness
Business analysis

Glamour, red carpets and impossibly attractive stars - cinema has always succeeded as a form of escapism; a welcome distraction from the travails of the real world. By this logic, the film industry can be seen to be counter-cyclical, meaning that unlike other industries it actually prospers during a recession, or a period of economic gloom. Indeed, looking at the evidence provided by America's National Association of Theater Owners, we see that box office revenues in the US have increased during five of the last seven recessions. Cinema also prospered during the Great Depression of the 1930s when, despite high unemployment and reduced incomes, Hollywood is reputed to have enjoyed its 'Golden Age'.

The current economic downturn seems to be bucking the trend, however, as cinema attendances and box office receipts have gradually started to fall over the last few months, though not to the extent of more high-brow forms of entertainment such as theatre and musicals. At least three major independent labels have been forced to close over the last year, whilst major studios Paramount Picturehouse, NewLine and Warner Independent have all had to lose 10 percent of their staff.

The reason? The feeling amongst several observers is that the industry (at least in North America and Europe) has reached saturation point which cannot be sustained by a faltering economy. The number of mainstream films on general release has increased by over 300% over the last 30 years - from 191 films released in US cinemas in 1978 to 603 in 2008. With a greater number of films on offer than ever before, the competition between production companies is intense, to add to the challenge faced from alternative media such as television, radio and the internet.

Internet killed the Cinema star...?

There is more competition than ever before for our free time. Ever since television was introduced to Western audiences in the late 1930s, the medium of cinema has had to contend with a growing number of challenges to its appeal. To its credit, the film industry has been able to successfully harness the growing array of alternative entertainment media over the years.

Nowadays, a mainstream film release will derive only a relatively small proportion (often less than 50%) of its commercial success from its cinematic release. The remainder of its income comes from television rights and DVD sales, as well as income from merchandising. These staple revenue streams will all take a hit over the coming months, however, as consumers buy fewer DVDs and film related merchandise, and TV network budgets are slashed following a fall in advertising sales leaving studios ever more reliant on box office sales to turn a profit.

Looking forwards, perhaps the biggest threat to the industry may be the advance of the internet, which has revolutionised our approach to entertainment. The success of this new medium has placed added pressure on traditional forms of entertainment such as cinema-going as younger people in particular have begun to spend more time online. Again, film studios have worked hard to harness the appeal of this new platform, for example, allowing users to download films from servers such as iTunes onto computers and portable devices. Legally downloaded films still account for a tiny fraction of this proportion, however. Movie piracy in its different forms is estimated to cost the film industry as a whole over $6 billion per year. (To illustrate the scale of the problem, it is thought that 99% of DVDs sold in China are pirated).

Funding Nemo

Faced by these challenges, film studios may be forced to tighten their belts, screening fewer new releases and sticking to tried and tested techniques such as universally popular franchises like the Batman series, rather than critically successful films which may have a narrower appeal. The cinematic release time of many films may also be reduced as dwindling audience numbers make it less economically viable.

Warner Brothers Entertainment, the film studio behind The Dark Knight, has already begun to illustrate a growing trend in the industry for reduced production rates, the studio releasing only 25 films in 2008, down from 40 the previous year. The company also recently announced that it would be cutting 800 jobs over the coming year as it looks to reduce expenditure.

The main problem facing film studios, however, is not the threat of falling attendances but rather the drop in financing available to producers. Producing films has always been a lucrative but also an inherently risky business. The potential commercial success of film production has long attracted major investment from the financial world, to private financiers, hedge funds, and major investment banks. In the United States, the largest film industry in the world is bankrolled to a large extent by major US investment banks such as Goldman Sachs, Merrill Lynch and Morgan Stanley. Having traditionally been one of the main providers of credit to major film studios like MGM and Universal, it now remains to be seen to what extent the credit freezes put forward by these banks will directly affect the financing of new releases going forward.

The predicament facing the industry is epitomised by the struggle experienced by Steven Spielberg, one of the most commercially successful producers and directors of all time, to secure funding for a new independent film company formed out of his existing DreamWorks brand and investment from Indian entertainment conglomerate, Reliance ADA. With a shortfall in funding, the deal was reliant on investment being provided by Spielberg's former studio, Universal, which was ultimately unwilling to put up the required amount. Talks fell through with Disney now thought to have come in as an 11th hour rescuer of the project.

Several major Hollywood studios have been following Spielberg's lead and looking to Asia as a new source of financial backing. In India and China in particular, rising income levels are rapidly boosting cinema audiences - India alone sells over four billion cinema tickets each year - whilst financing for film projects is still relatively healthy in comparison to the West. MGM is believed to have held recent talks with Reliance ADA with an opportunity for the Indian firm to come in as an investor. Meanwhile, Weinstein Company, a newly established independent venture which has produced titles including Rambo and Transamerica, may also look towards Asia for much needed funding having lost its financing from Goldman Sachs.

Hedging their bets

In the UK, meanwhile, the hedge fund industry has taken a lead role in the bankrolling of British cinema over the last decade. The UK film industry finds itself in an unusual predicament. On the one hand the appeal of cinema is healthier than it has ever been: box office sales in the UK and Ireland reached an all-time high of £950 million in 2008 despite the onset of recession and rising unemployment. Meanwhile, British or British-made films with foreign backing enjoyed unprecedented commercial success around the globe, accounting for 31% of world box office revenues. At the same time, however, financing for big budget films in this country has started to fall, down 23% on the level of investment seen in 2007. The year ahead is shaping up to be harder still for the UK film industry as most films produced in 2008 had secured financing at an earlier date which allowed them to carry through to production. Films which have been canvassing for credit over the last few months and going forward look set to have a much tougher time.

The hedge fund industry has invested a total of $13 billion in film production in recent years with a large proportion of this going into British films. However, the stock market crashes of 2008 in addition to falling commodity and real estate prices made it a tough year for many funds with average returns on investment by the industry a devastating minus%. This poor performance has led to a wave of redemptions (the withdrawal of money by investors) with a total of total of $155 billion taken out last year alone. Given the hardships being felt by the hedge fund world, it is suspected that the film industry may lose one of its most lucrative sources of finance. The one silver lining for British film studios is that the weakness of the Pound should drive a greater number of US film makers to co-produce films in the UK, taking advantage of reduced costs.

The next dimension

The film industry may have little control over the credit market and the decisions of its backers within the financial sector. Its primary objective, meanwhile, must be to ensure that cinema continues to capitalise on its strong appeal and to ensure that it doesn't lose out to other forms of popular entertainment, namely TV and the internet. One way it might seek to do this would be to find new ways of 'spicing up' the medium so as to capture an even greater percentage of the market share.

New developments have traditionally worked in drawing in customers - in the 1930s, film fought off the threat posed to attendance levels from mass unemployment through the recent innovation of new sound-tracked movies, or talkies. It also introduced the 'double feature' - films shown back to back which proved to be particularly popular with the unemployed. In 2009 the equivalent of these innovations might be 3-D films, a medium which dates back to the 1920s, but one which has not been properly harnessed until now. The recent advance of digital film techniques is starting to find its way into the world of 3-D film implying that the gimmicky red and green cardboard specs may soon be a thing of the past. Steven Spielberg recently revealed that he is involved in patenting a 3-D cinema system that does not need glasses and greater numbers of film producers may choose to adopt the format as standard as they seek to draw in new audiences, particularly the key under 25 bracket.

One thing is certain: cinema will have to do its best to remain hip and current if it is to survive the global downturn. As people lose their jobs and have less money to spend, audiences will be in greater need of escapism than ever, but by the same token, they may start to lose patience with high ticket prices bankrolling the multi-million dollar contracts of stars like Will Smith and Scarlett Johansson. Cheaper screenings and special incentives may be needed to ensure audience figures continue their upward trend; alternatively more economical forms of entertainment like TV and the internet will offer fiercer competition for our free time than ever before. The red carpet undoubtedly has plenty of life left in it but there may well be fewer well-healed protagonists parading down it over the coming years.

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