It is a pleasure to have been invited here today to speak to you. [Introductory words]

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2 Audiovisual Industry Seminar WTO, Geneva, Wednesday 4 July 2001 Speech on "The economics of the sector - the UK example" Michael Flint, Deputy Chairman, BSAC [Slide 1] It is a pleasure to have been invited here today to speak to you. [Introductory words] This afternoon I hope to show, by specific reference to the UK market, how the film industry in Europe operates, and how it is placed in relation to the international marketplace. The industry can be viewed in three parts: = = = production distribution exhibition. I shall consider each of these sectors in turn. The production industry in the UK and indeed throughout the EU is what we call a cottage industry with few exceptions: that is to say, films in the UK are largely produced by small undercapitalised companies which rely entirely upon the freelance labour market to crew their films when they are ready to shoot. They do not own studios. They do not own their cameras, lighting, and sound equipment. Everything and everyone is hired on an ad-hoc basis. This is largely because the EU national markets are too small to enable the producers and their financiers to recoup their production investment in their own countries. Due to language and cultural differences, very few films produced in one EU country can obtain distribution throughout the rest of the EU. [Slide 2 Gross UK box office by nationality of film (2000)] The production treaties between EU countries go some way to alleviate this problem. This pie chart shows as British films, those registered as British films, without differentiating between those which are or are not co-productions.

3 2 How does a UK producer go about setting up his film? Well, having identified the subject of his film, he commissions a writer. But screenwriters who have written commercially successful films are very, very expensive, so most of them now work in Hollywood or are employed by production companies owned by US major studios. They are too expensive for the average European producer to pay to write his film. He must therefore seek assistance from national funding agencies such as the Film Council or EU funds such as the Media Programme. When the script is approved and the pre-production work location selection, budget, casting, etc. is finished, he must seek the full funding for his picture. No independent production company, certainly in the UK and I believe in the rest of Europe, is able to finance a film from its own resources. The source of production funding will depend upon many factors but above all upon the size of the budget and the market for which the film is intended. If the film is intended for the international market, it is generally accepted that it cannot be made for less than US $25 million smaller films do very occasionally succeed but they are freaks. If a film is to be made for more than $25 million, it will have to have secured distribution in the US for an advance of about 35% of the budget. The large part of the rest of the financing will come from pre-sales to national distributors throughout the rest of the world, which are discounted by a bank. But almost invariably there will be a gap. This might be filled by equity investors but is normally filled by a state aid financing advance tax shelter finance or a soft loan from the Film Council or the Media Programme. In the case of films costing $10 million or less very few films are made for between $10m and $25 million the pattern is similar, except that the US 35% distribution advance will usually be impossible to find. In these cases, European TV companies in the UK, primarily the BBC and Film Four are a primary source of funds. Other principal sources will be a coproduction partner from any of the EU Member States. The rest of the funding will come from pre-sales to national distributors outside the USA, but again there will usually be a gap which can be filled only by one of the state aids tax shelter finance or national or Media Programme funding. [Slide 3 Total value of UK feature film production (2000)] There were 77 films made by UK producers in 2000, including co-productions; and a further 13 foreign films were shot in the UK, which were almost entirely US studio productions. The total value of these 90 films was $1.1 billion, of which the foreign productions accounted for just over half. While the average budget of the UK-producer films was just under $7 million, the foreign i.e. mostly American films were budgeted at $44 million on average.

4 3 Let me now turn to the distribution sector. The distribution of a film must be distinguished from its exhibition. A distributor enters into agreements with cinema owners for its films to be exhibited. The distributor pays for the cost of making the prints and advertising the film. The exhibitor, that is to say the cinema owner, keeps a percentage of the box office receipts which, in the UK, is more than 50%. The distributor s share of box office receipts is first applied in recouping its cost of prints and advertising. The distributor also keeps a percentage typically about 30% as its fee. Then the distributor's share of box office receipts is applied towards recoupment of the advance paid to the producer for the right to distribute the film. The rights taken by the distributor include not only the right to show the film in the cinemas but also to issue it on video and to licence it for pay and free television, pay-per-view television and Internet distribution (even though the technology does not yet exist to permit Internet distribution on a commercial basis of feature films). In the UK, the distributors are largely US-controlled companies. [Slide 4 Distributor share of UK theatrical market (2000)] In the UK, there are no state aids, tax shelters or other non-gats compliant measures that apply to the distribution of film in cinemas or to the issue of them on video. However, the UK has implemented the Television Without Frontiers Directive by providing that at least 50% of fiction programmes on BBC and commercial free television are European products, which gives added value to European films. The 50% quota is also applicable to films: pay-tv services such as the Sky movie channels are subject to the quota on a progressive basis. In the USA, the cost of advertising a film is typically equivalent to its budget $50 million to advertise a $50 million film in the USA alone. European distributors, releasing small budget films most of the time, with much smaller expected box-office grosses than the blockbuster US films, are not able to spend proportionate sums in advertising European films. US companies can and do spend huge sums on advertising their films in Europe, through their distribution subsidiaries. This greatly enhances their TV & video values, almost irrespective of their box office success. This leads me on to the third sector: exhibition. The success of films at the box-office is critical because despite the rise of television, video and now DVD, the cinema remains the most important market for film. Success in the cinema drives success in the other media.

5 4 [Slide 5 Relative size of domestic revenues for British films (1996)] My next slide shows the relative importance of each medium in the UK but I suspect the picture would be approximately the same for most major territories around Europe. As you can see, the box-office accounts for less than a quarter of a film s revenues. I have used 1996 as an example because that is the most recent year for which reliable television data is available but the situation remains much the same today. As a result, it is necessary to spend very significant sums on advertising to ensure that a film has an opportunity to reach its potential audience at the cinema and this, as we shall see in a moment is where significant advantages accrue to companies of size. In the UK, there are no national state aids for exhibitors, apart from a subsidy for a small network of regional art house cinemas. Nor are there any screen quotas. As regards EC funding, exhibitors do have access to the Media Programme aid system, which is a useful but relatively small amount of money. [Slide 6 Number of multiplex screens in UK (1999)] Since the mid-1980s, cinema admissions in the UK have almost tripled; from a post-war low of 52 million in 1984, they soared to million by last year. This has been driven largely by the growth of multiplexes which has in turn been largely funded by American companies. As a result they now account for just under 50% of the multiplex screens in the UK as can be seen in my next slide. [Slide 7 Market Share of US Films in the six year periods before and after the completion of the Uruguay Round] As this slide shows, and as we all surely know just by glancing at the billboards in any European town or city, American films remain the market leaders at European cinemas. These American films are overwhelmingly distributed by a handful of major US studios, all based in Hollywood namely Disney, MGM, Paramount, Sony, Twentieth Century Fox, Vivendi Universal and Warner Brothers. While Universal is now owned by the French conglomerate Vivendi and Sony is owned by the Japanese, to all intents and purposes all the creative and marketing decisions take place where they have always taken place in an area no bigger than a few square miles in Los Angeles. In fact, the studios have dominated the European market since the introduction of sound in the late 1920s. There has been a slight decline in the overall market share across the EU since the Uruguay Round, but in practical terms the impact of this has been negligible.

6 5 As you can see, in the case of the British market however, the share held by the Americans has declined a little more significantly there are two reasons for this. The first is the introduction of Government measures to help stimulate film production. Since 1995, funds raised through the proceeds of the National Lottery have been available to help support the production costs of selected British films such as Billy Elliot. And two tax reliefs are available to help stimulate production most notably a 100% first year write-off against production costs introduced in Most importantly, such public support helps to lever in private finance. The second factor driving the success of British films has been an influx of American money to produce and distribute films such as The Full Monty and Bridget Jones s Diary. This combination of national public support and the openness of the market to overseas money has, without question, facilitated the production of films which have had success in finding audiences. Without such subsidies, the British production industry would unquestionably be even more fragile, even more precarious than it already is and audiences across the world would be deprived of the chance to see many films created in Britain on British themes. [Slide 8 Market share of US and domestic films in Europe (1999)] My next slide shows market share in more detail country by country across Europe. While some markets are stronger than others, notably France where indigenous films accounted for 32% of the market in 1999 largely thanks to a complex but highly effective subsidy system - the basic pattern is the same throughout the continent; American films distributed by American companies dominate the market. Historically, local cinema in Sweden and Denmark has also held up remarkably well, again largely as a result of the availability of subsidies, but even here the share is no more than around 25%. Finally, let me turn to the economics of the film industry, and ask how the US studios have succeeded in building such a dominant position in the European market and elsewhere. In particular, how have they succeeded, where local industries such as that of the UK (which even shares the same language as the US) have so manifestly failed? Their main advantage lies in the size of the market in the US. The size of the population in the US is five times that of the UK. The studios can typically finance a very significant proportion of the budget of the biggest films on the basis of expected domestic receipts. This is the case, even allowing for the fact that the average costs of the films produced by the major studios reached $54.8m in up more than 200% in real terms since the late 1980s, largely due to the increasing costs of the major stars. In the EU, we now have a single market. But, where films are concerned, because they are in fact cultural creations which use different languages, and are based on different cultural backgrounds, we have 15 different markets.

7 6 Another answer lies in the industrial structure of the American film business. The US film industry is built around companies which have a global vision, and whose distribution-led strategy is based on the acquisition and exploitation of Intellectual Property Rights. The major film studios based in Hollywood use their own distribution infrastructure to exploit films around the world and use the resulting earnings to support development and production, as well as to grow their companies and reward their investors. In short, the US industry is distribution-led. With a regular flow of product, the studios can service their own (theatrical and video) distribution and exhibition arms in the US and internationally. And as global players, they can exploit merchandising opportunities all over the world. Thus, by controlling the rights across various windows and in many major territories, the studios ensure that they retain the lion s share of the revenue streams that accrue to their films. This enables them to keep on financing their own films completing the virtuous circle. This helps to explain why the US accounts for about 90% of all film exports in Europe. This is also why American distributors of films accounted for 80% of the market in the UK in 2000, as I showed in a previous slide. As I said earlier, support from the National Lottery and tax breaks has been invaluable in helping to boost levels of production in the UK, as we can see from my final slide. [Slide 9 Total value of film production in the UK in million (2000 prices), ] Although we have to be careful about drawing too many conclusions about the correlation between public support and increased levels of production, the upward trend in recent years is very clear. The British distribution and exhibition sectors, like those of their counterparts across Europe, have been stimulated by investment from American companies. This investment from across the Atlantic has been critical to the success of the retail end of the UK cinema across the world market. Without the support of these American companies, British films would have even less chance of reaching world markets. But equally, without subsidies in the form of tax relief and money from the National Lottery many of these films would never be made. This would have diminished cultural diversity and denied audiences in the UK and across the world the chance to appreciate and enjoy many fine British films. Thank you very much for listening. I will be happy to take questions. Ends.

8 Presentation to WTO Trade Representatives by Michael Flint (BSAC) Geneva, 4 July

9 United Kingdom 18% Other Europe 1% Other <1% United States 80% Gross Box office total: 581m Source: Dodona Research 2

10 Number US $ million of films Value Average budget UK productions (incl. co-productions) 77 $515 $6.7 Foreign productions shooting in UK 13 $570 $43.8 All films 90 $1,110 $12.3 Source: Screen Finance 3

11 Columbia TriStar 19% Other 4% Warner Bros 10% 20th Century Fox 15% Film Four Distribution 3% Pathe Distribution 10% Entertainment 6% Market Share of US majors: 81% Buena Vista 33% Source: Dodona 4

12 Terrestrial TV 22% Theatrical Exhibition 23% Pay TV 20% Video sellthrough 19% Video Rental 16% Source: London Economics (All Industry Fund Model for the Department for Culture, Media and Sport) 5

13 ABC 2% Cine UK 8% Other (Inc Independents) 4% UCI 18% UGC 16% Warner Village (US/Australian) 16% Odeon 23% National Amusements 13% US Majors 46.9% Source: Screen Finance 6

14 Market Share of US Films in the six year periods before and after the completion of the Uruguay Round Territory Change European Union 72% 71% -1.2% UK 88% 79% -8.9% Other EU Member States 70% 69% -0.6% Source: BSAC calculations 7

15 90% 80% 70% Domestic US 68% 81% 75% 64% 76% 77% 71% 60% 54% 59% 59% 55% 50% 40% 32% 30% 26% 25% 20% 21% 20% 18% 14% 14% 10% 0% 5% 4% 0.3% France Denmark Finland Sweden Italy United Kingdom Germany Spain Netherlands Belgium Luxemburg Source: Media Salles, Cinetel (Italy), DDA (Germany), Screen Finance (UK), Dodona Research 8

16 Total value of film production in the UK in million (2000 prices), Source: BFI Handbook 2001, Screen Finance, ONS, BSAC calculations 9

Appendix H: International Production Support Program

Appendix H: International Production Support Program Fear of U.S. as content Hub 630 631 Leads to Protectionism in Content Imports Arguments for Content Protectionism National culture Employment Projection