CASE 1 36 0 China s A Horror Home ShowImprovement at the Market: Should Home Depot Cinemaplex? Enter or Will it Have a LateMover (Dis)advantage? Steve Gove Virginia Tech Brett P. Matherne Loyola University of New Orleans If the motion picture industry s performance in 2007 were a feature presentation, the marquee would read Massive Box Office: Smashing Records the Sequel! At $9.63 billion, box office revenue set another record in 2007, a full 5 percent above the record set in 2006.1 An astonishing 1.4 billion tickets were sold in 2007. But beyond the headlines, the industry is a study in contradictions: The number of theaters is declining, but the number of screens is at an all-time high. Revenues are up, but attendance is largely flat 1.4 billion tickets sold is little improved from 1997, when 1.35 billion tickets were sold, and is a fraction of the 4 billion sold in 1946. In 1946, the average person attended 28 films a year. Today, it is 6.2 (see Exhibits 1 and 2). The U.S. population is increasing, but the size of the market in the core demographic group is growing more slowly (see Exhibit 3). Americans spend more time than ever on entertainment 3,500 hours annually but only 12 of those hours are spent at the movies.3 The average person watches that much television every three days. Movies remain as popular as ever, but opportunities for viewing outside the theater have greatly increased. While motion picture studios increased revenues through product licensing, DVD sales, and international expansion, the exhibitors movie theaters have seen their business decline. Movies are more available than ever, but fewer are venturing to the theater to see them. Many theaters have ceased operation, driven from the market by consolidation and a lack of patrons. Will the marquee at the local theater soon change to: A Horror Show at the Cinemaplex? How has this come to be? What can exhibitors do to respond? Exhibit 1 Domestic Tickets Sold and Box Office Gross 10 9 8 7 6 Tickets Sold (billions) 5 4 Box Office Gross ($ billions) 3 2 1 0 1983 1988 1993 1998 2003 2008 Source: http://boxofficemojo.com & U.S. Census. 217 CHE-HITT-09-0102-Case-016.indd 217 11/14/09 2:34:24 AM
218 Exhibit 2 Average Movie Ticket Price $7.00 $6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 1983 1988 1993 1998 2003 2008 Source: http://boxofficemojo.com. The Motion Picture Industry Value Chain The motion picture industry value chain consists of three stages: studio production, distribution, and exhibition. All stages of the value chain are undergoing consolidation. Studio Production The studios produce the lifeblood of the industry; they create content. Films from the top 10 studios produce over 90 percent of domestic box office receipts (see Exhibit 4). Studios are increasingly part of larger corporations, managed as any other profit center. Management is a challenge as investments are large and there is no one formula for success. Because of this, profitability swings wildly. The cost of bringing a typical feature to market is more than $100 million, up 25 percent in the past five years. 4 Typically, marketing expenses are a third of these costs. Studios know their core audience is 12 to 24 years old. This age group purchases nearly 40 percent of theater tickets. Half are frequent moviegoers attending at least one movie per month. Profits are driven by the studios ability to satisfy this fickle audience. In 2008, films based on two successful comic book characters met Exhibit 3 Population Trend among 14 to 17 and 18 to 24 Age Groups (Millions) 60 50 18 to 24 years 14 to 17 years 40 30 20 10 0 2008 2010 2015 2020 2025 2030 2035 2040 2045 2050 Source: U.S. Census. CHE-HITT-09-0102-Case-016.indd 218
219 Exhibit 4 Market Share of Film Production (2007) Studio Parent & Label Time Warner (Warner Brothers & New Line) 2007 Combined Share (%) 19.8 Sony (Sony & MGM) 16.7 Viacom (Viacom & Paramount) 15.5 Disney (Disney, Buena Vista Pictures, & Miramax) 15.4 Universal Studios 11.4 News Corp. (20th Century FOX) 10.5 Lions Gate 3.6 DreamWorks SKG* 0.0 Note: *DreamWorks share in 2005 was 5.7%. 92.9 Source: Adapted from Mintel Report: Movie Theaters, United States, February 2008. with wildly different fates. 5 Paramount s successful Iron Man was produced for $140 and grossed $318 million at the domestic box office. Warner Brothers s Speed Racer, produced for $20 million less and released the following weekend, was a flop, grossing just $44 million. Demographic trends are unfavorable. The U.S. population will increase 17 percent by 2025, an increase of 54 million people. However, the number of 12- to 24-year-olds is expected to increase only 9 percent just 4 million more potential viewers. Based on the current number of theaters and screens, this is an increase of less than 700 additional viewers per theater, or roughly 100 per screen. Distribution Distributors are the intermediaries between the studios and exhibitors. Distribution entails all steps following a film s artistic completion, including marketing, logistics, and administration. Exhibitors negotiate a percentage of gross from the studio or purchase rights to films and profit from the box office receipts. Distributors select and market film to exhibitors, seeking to maximize potential attendees. Distributors coordinate the manufacture and distribution of the film to exhibitors. They also handle collections, audits of attendees, and other administrative tasks. There are over 300 active distributors, but much of this work is done by a few major firms, including divisions of studios. Pixar, for example, co-produced Finding Nemo with Disney and distribution was handled by Disney s Buena Vista. Exhibition Studios have historically sought full vertical integration through theater ownership, allowing greater control over audiences and capturing exhibition profits. A common practice was for the studio to use their ownership to reduce competition by not showing pictures produced by rivals. This practice ended in 1948 with the Supreme Court s ruling against the studios in United States v. Paramount Pictures. Theaters were soon divested, leaving them to negotiate with studios for film access and rental. Theaters are classified according to the number of screens at one location (Exhibit 5). Single-screen theaters were the standard from the introduction of film through the 1980s. They have since rapidly declined in number, replaced by theater complexes. These include miniplexes (2 to 7 screens), multiplexes (8 to 15 screens), and megaplexes (16 or more screens). The number of theaters decreased more than 15 percent between 2000 and 2007, but the number of screens increased because of growth in megaplexes. Nearly 10 percent of theaters are now megaplexes, and the number of screens is at a historical high of 40,077. 6 Many analysts argue the industry has overbuilt and too many theaters and screens exist to make the business profitable. Movie attendance usually increases as the economy declines. In 2008, there were rapid increases in gas prices, a large stock market decline, and significant layoffs. One summer movie patron commented, There s not a whole lot you can do for $10 anymore. 7 Movies do remain a Exhibit 5 Number of Theaters by Complex Size 2000 2007 % Change Single Screens 2,368 1,748 26.18% Miniplexes (2 7 Screens) 3,170 2,296 27.57% Multiplexes (8 15 Screens) 1,478 1,617 9.40% Megaplexes (16+ Screens) 405 616 52.10% Total 7,421 6,277 15.42% Sources: Developed by author from: Entertainment Industry, 2007 Report, Motion Picture Association of America, and Mintel Report Movie Theaters, United States, February 2008. CHE-HITT-09-0102-Case-016.indd 219
220 Exhibit 6 Exhibition Market Leaders Company Theater Brands # U.S Theater Locations # U.S. Screens Avg. Screens per Theater Regal Regal, United Artists, Edwards 526 6,355 12 AMC AMC, Loews 315 4,585 14 Cinemark Cinemark, Century 284 3,606 12 Carmike Carmike 280 2,412 8 Total for four leading companies 1,405 16,958 Industry total 7,421 40,077 Source: Mintel Report Movie Theaters, United States, February 2008, SEC filings and author estimates. bargain in the entertainment business. Four tickets to a movie can cost under $27 (depending on the time of day and location) compared to $141 for an amusement park or $261 for a pro football game. 8 For many, the air-conditioned comfort of a dark theater and the latest Hollywood release offer a break not just from the summer heat, but from reality. It s escapism, absolutely. It s probably a subconscious thing, and people don t realize it. But there s just so much going on, with people trying to pay their mortgages and get by. It s an escape for a couple of hours. 9 Declining ticket sales and the increased costs associated with developing megaplexes led to a wave of consolidation among exhibitors. There are now four dominant exhibitors: Regal, AMC, Cinemark, and Carmike. While operating 1,405 theaters in the country (just 19 percent), these companies control 42 percent of screens. This market share provides these exhibitors with negotiating power for access to films, prices for films and concessions, and greater access to revenues from national advertisers. There is little differentiation in the offerings of the major theater exhibitors prices within markets differ little, the same movies are shown at the same times, and the food and services are nearly identical. Competition between theaters often comes down to distance from home, convenience of parking, and proximity to restaurants. Innovations by one theater chain are quickly adopted by others. The chains do serve different geographic markets and do so in different ways. 10 Regal focuses on mid-size markets using multiplexes and megaplexes. Regal s average ticket price of $7.43 is the highest among the leaders. AMC concentrates on urban areas with megaplexes and on large population centers, such as those in California, Florida, and Texas. Cinemark serves smaller markets, operating as the sole theater chain in over 80 percent of its markets. Cinemark s average ticket price last year of $5.11 was the lowest of the majors. Carmike concentrates on small to mid-sized markets, targeting populations of less than 100,000 that have few other entertainment options. Carmike s average ticket price in 2007 was $5.89, but at $3.05, their average concession revenue per patron is the highest among the majors. The different approaches of the companies are reflected in the cost of fixed assets per screens. These costs result from decisions made on how to serve customers, such as the level of technology and finish of the theater digital projection and marble floors cost more than traditional projectors and a carpeted lobby. 11 Despite multi- and megaplex facilities, Regal s cost per screen is the highest at $430,000. Carmike, the rural operator, is the lowest at just $206,000. Cinemark is in the middle at $367,000. Data is not available for AMC, but costs are thought to be near or above those of Regal. The Business of Exhibition There are three primary sources of revenue for exhibitors: box office receipts, concessions, and advertising. Managers have low discretion; their ability to influence revenues and expenses is limited. Operating margins among exhibitors average a slim 10 percent. This is before significant expenses such as facility and labor costs. The result is marginal or negative net income. Overall, the business of exhibitors is best described as loss leadership on movies: the firms make money selling concessions and showing ads to patrons who are drawn by the movie. CHE-HITT-09-0102-Case-016.indd 220
221 Box Office Revenues Ticket sales constitute two thirds of exhibition business revenues. The return on these receipts, however, is quite small. A power imbalance results in contracts that return the vast majority of box office receipts to the studios. The record-setting revenues at the box office have been the result of increases in ticket prices and have flowed back to the studios. Concessions Moviegoers frequently lament the high prices for concessions. Concessions average 25 to 30 percent of revenues. Direct costs are less than 15 percent of the selling price, making concessions the largest source of exhibitor profit. These are influenced by the three factors: attendance, pricing, and material costs. The most important is attendance: more attendees equal more concession sales. Sales per patron are influenced by prices. The $3.75 price point for a large soda is not by accident, but the result of market research and profit-maximization calculation. Costs are influenced by purchase volume, with larger chains able to negotiate better prices on everything from popcorn and soft drinks to cups and napkins. Advertising Exhibitors also generate revenue through pre-show advertising. Though this constitutes just 5 percent of revenues, it is highly profitable. Mintel reports that advertising revenues among exhibitors are expected to increase at a rate of approximately 10 percent over the coming decade. 12 Audiences signal consistent dislike for advertising at the theater. Balancing the revenues from ads with audience tolerance is an ongoing struggle for exhibitors. Overall, the exhibitor has limited control over both revenues and profits. Box office receipts are the bulk of revenues, but yield few profits. Strong attendance numbers allow for profitable sales of concessions and advertisements, but there are significant caps on the volume of concession sales per person and selling prices seem to have reached their maximum. Advertising remains an attractive avenue for revenues and profits, but audiences loathe it. The Process of Exhibition The fundamentals of film exhibition have changed little since the early 1940s. To show a picture, each theater receives a shipment of physical canisters containing a release print from the distributor. Making these prints requires $20,000 to $30,000 in up-front costs and $1,000 to $1,500 for each print. Thus, a modern major motion picture opening on 2,500 screens simultaneously requires $2.50 to $3.75 million in print costs. This is borne by the studios, but paid for by movie attendees. Each release print is actually several reels of 35-mm film, which are manually loaded onto projector reels, sequenced, and queued for display by a projector operator. The film passes through the projector, which shines intense light through the film, projecting the image through a lens that focuses the image on the screen. A typical projection systems costs $50,000, with one needed for each screen. Digital cinema is becoming economically viable. Digital cinema involves a high resolution (4096 2160) digitized image projected onto the screen. Basic digital systems cost $150,000 to $250,000 per screen. Conversion of an existing eight-screen theater to digital thus involves an investment of $1.2 to $2 million. The costs for digital release prints are far lower than traditional film, but these costs savings most directly benefit the studio whereas the exhibitors must pay any costs to convert theaters. The number of digital theaters is expanding rapidly. In 2004, there were less than 100, and there are now approximately 4,600, or 12 percent of screens. Because of the cost involved, most theaters use a mixture of technologies, with a minority of screens in any one facility featuring digital projection. The Theater Experience For a significant number of moviegoers, the draw of the theater is far more than what film is showing. Moviegoers describe attending the theater as an experience, with the appeal based on: 13 the giant theater screen the opportunity to be out of the house not having to wait to see a particular movie on home video the experience of watching the movies with a theatrical sound system the theater as a location option for a date The ability of theaters to provide more than what audiences can experience at home appears to be diminishing. Of the reasons why people go to the movies, only the place aspects the theater as a place to be out of house and as a place for dating may be immune from substitution. Few teenagers want to watch a movie and eat popcorn with their date at home with their parents next to them on the sofa. The overall experience currently offered by theaters falls short for many. Marketing research firm Mintel reports the reasons for not attending the theater more frequently are largely the result of the declining experience. Specific factors include the overall cost, CHE-HITT-09-0102-Case-016.indd 221
222 at-home viewing options, interruptions such as cell phones in the theater, rude patrons, the overall hassle, and ads prior to the show. 14 A recent Wall Street Journal article reported on interruptions ranging from the intrusion of soundtracks in adjacent theaters to cell phones. The interruptions capped a night of moviegoing already marred by out-of-order ticketing kiosks and a parade of preshow ads so long that, upon seeing the Coca-Cola polar bears on screen, one customer grumbled: This is obscene. 15 Recounting bad experiences is a lively topic for bloggers. A typical comment: I say it has gotten worse. I hate paying $9.00 for a ticket and the movie is 90 100 minutes long, people talking on the cell phone, the people who work at the theaters look like they are bored, and when you ask them a question, the answer is very rude. I worked as an usher in the late 60s and we had to wear uniforms and white gloves on Friday and Saturday nights, those days are long gone. 16 A trip to the local cinemaplex can be eye opening even for industry insiders. In 2005, Toby Emmerich, New Line Cinema s head of production, faced a notso-common choice: attending War of the Worlds in a theater or in a screening room at actor Jim Carrey s house. Said Emmerich in an LA Times article, I love seeing a movie with a big crowd, but I had no idea how many obnoxious ads I d have to endure it really drove me crazy. After sitting through about 15 minutes of ads, I turned to my wife and said, Maybe we should ve gone to Jim Carrey s house after all. 17 The unique value proposition offered by movie theaters large screens, the long wait for DVD release, and advantages of theatrical sound systems also appears to be fading. Increasingly larger television sets, DVD content, and the adoption of high-definition technology are all part of this change. One blogger posts, Whereas the electronics industry has been innovating to create immersive experiences from the comfort of our own home, the US theater industry has been dragging their feet. 18 Home Viewing Technology Home television sets are increasingly large, highdefinition sets coupled with inexpensive, yet impressive audio systems. In 1997, the screen size of the average television was just 23 inches. Currently, almost half of LCD televisions sold have screens 36 inches or larger. 19 Because set size is measured as the diagonal screen size, increases in viewable area are greater than the measurement suggests. In recent years, the viewing area of sets doubled from 250 inches to 550 inches. The FCC requirement that all broadcasters convert to digital broadcasts by June 12, 2009, is widely credited with starting a consumer movement to upgrade televisions. Since the 1950s, television transmissions were formatted as 480 interlaced vertical lines (480i) of resolution. The new digital format is high definition (HD), providing up to 1080 vertical lines of resolution (1080p). 20 Three quarters of all televisions sold since 2006 are HD capable. As LCD technology became the standard for both computer and television screens, manufacturing costs declined. Wholesale prices for televisions fell 65 percent from the late 1990s to 2007. 21 In 2006, the average television retailed for $29 per diagonal inch of set size. This is expected to decrease to $22 within five years. 22 Consumers, however, are actually spending more on every television, consistently electing to purchase larger sets to achieve a better viewing experience. Sharp, a leading manufacturer of televisions predicts that by 2015 the average screen will reach 60 inches. 23 Large screen televisions, DVD players, and audio and speaker components are commonly packaged as low-cost home theaters. The average DVD player now costs just $72 24 and high-definition DVD players are beginning to penetrate the market. Retail price wars during the 2008 Christmas season led to HD Blu-Ray players dropping below $200. These home theater systems offer a movie experience that rivals many theaters, all for $1,000 to $2,000. Says Mike Gabriel, Sharp s head of marketing and communications: People can now expect a home cinema experience from their TV. Technology that was once associated with the rich and famous is now accessible to homes across the country. 25 Content Availability and Timing Even the best hardware offers little value without content for display. Rental firm Netflix advertises a selection of more than 100,000 titles extending well beyond new and classic films to include television shows, sports, and music performances. HD content is increasingly available to maximize the experience offered by those HD televisions. Satellite and cable television providers have engaged in a game of one-upmanship to provide the greatest percentage of HD content available to subscribers. By the end of 2009, 2,000 movies were available on Blu-Ray DVD. 26 Movie fans no longer have to wait long for the summer s blockbuster to appear on DVD. The time period between theatrical and DVD release has declined 40 percent since 2000. The top five films in 2000 were released on DVD an average of 37 weeks after their box office opening. In 2007, the lag was just 23 weeks. And, studios are experimenting with simultaneous releases to theaters, pay per view, and DVD. CHE-HITT-09-0102-Case-016.indd 222
223 Overall, the visual and audio experience available in the home is rapidly converging with that available at the movie theater. As a blogger on the movie fan site Big Picture posted: I used to go to the movies all the time even my blog is called the Big Picture. Then I started going less and then less still NOTES 1. Motion Picture Association of America (MPAA), 2007, Entertainment industry market statistics. 2. A. Serwer, 2006, Extreme makeover: With big screens and high-def in more and more living rooms, movie theaters are taking radical new measures to woo filmgoers, Fortune, 153: 108 116. 3. Mintel Report, 2008, Movie theaters U.S., February. 4. MPAA, 2007, Entertainment industry market statistics. 5. All data on these two films from http://www.boxofficemojo.com. 6. Developed by author from: Entertainment Industry, 2007 Report, Motion Picture Association of America. 7. J. Woestendiek & C. Kaltenbach, 2008, $10 is small price for a big escape: Movie box office figures are flourishing despite, or because of, economic worries, Baltimore Sun, July 8. 8. MPAA, 2007, Entertainment industry market statistics. 9. J. Woestendiek & C. Kaltenbach, 2008, $10 is small price for a big escape: Movie box office figures are flourishing despite, or because of, economic worries, Baltimore Sun, July 8. 10. Data on the firms, screen sizes, location, from Web sites and SEC filings. 11. All data is from SEC filings, based on net property, plant, and equipment reported in 2007 balance sheet and on the number of screens. 12. Mintel Report, 2008, Segment performance: cinema advertising, Movie theaters U.S., February. 13. Mintel Report, 2008, Reasons to go to the movies over watching a DVD, Movie theaters U.S., February. and now hardly at all. My screen at home is better, the sound system is better, the picture is in focus, the floors aren t sticky and the movies start on time. My seat is clean. And there s no idiot chattering away 2 rows behind me, and (this is my favorite) THERE S NO CELL PHONES RINGING. EVER. 27 Is this a horror show at the cinemaplex? 14. Mintel Report, 2008, Reasons why attendance is not higher, Movie theaters U.S., February. 15. K. Kelly, B. Orwall, & P. Sanders, 2005, The multiplex under siege, Wall Street Journal, December 24, P1. 16. Blog comment, Over the past years, http://cinematreasures.org/ polls/22/ (accessed December 11, 2008). 17. Incident reported in Patrick Goldstein, 2005, Now playing: A glut of ads, Los Angeles Times, July 12, E-1. 18. Designs of the week: The Movie Theater Experience, 2008, November 23, http://www.sramanamitra.com/2008/11/23/designsof-the-week-the-movie-theater-experience/. 19. DuBravac, 2007. 20. DuBravac, 2007. 21. DuBravac, 2007. 22. B. Keefe, 2008, Prices on flat-screen TVs expected to keep falling, Atlanta Journal-Constitution, March 15. 23. Average TV size up to 60-inch by 2015, says Sharp, TechDigest, http://www.techdigest.tv/2008/01/average_tv_size.html (accessed December 11, 2008). 24. MPAA, 2007, Entertainment industry market statistics. 25. Average TV size up to 60-inch by 2015, says Sharp, TechDigest, http://www.techdigest.tv/2008/01/average_tv_size.html (accessed December 11, 2008). 26. http://www.movieweb.com. 27. The Big Picture, Why is movie theatre attendance declining?, http://bigpicture.typepad.com/comments/2005/07/declining_movie.htm (accessed December 11, 2008). CHE-HITT-09-0102-Case-016.indd 223