Book Review: The Big Picture

The Big Picture: The New Logic of Money and Power in Hollywood
by Edward Jay Epstein
Random House, 2005

Edward Jay Epstein occupies the strange position of being a Hollywood columnist – but one who focuses on the business side of Hollywood rather than the razzle-dazzle. That is a unique niche to be in, but it's also a very small one. When times got tough in the magazine business, Slate dropped his Hollywood Economist column, and Epstein now gets his film-business commentary out through his blog.

Hollywood Economist

But he's absolutely right to point out that the news media rarely covers the substantial parts of the film business. All the focus on box-office receipts obscures the fact that the box office is no longer so important to profitability.  A film need only do well enough to guarantee an afterlife, in which the real money gets made. On the other hand, the shallow focus on box office grosses is not unique to Hollywood. Most business coverage in newspapers is awful, whatever the industry. They focus on big day-to-day events, and rarely do the simple arithmetic to explain the economic fundamentals that drive whole industries.

Epstein, in contrast, breaks down stunning news developments into the fundamental driving forces that made them inevitable. For example, why did MGM go into bankruptcy in 2010?  Because its last deal was heavily financed by debt and relied on DVD sales for debt servicing. When DVD sales faltered, the lion's roar was silenced. And, oh, by the way, Sony used this to pull a fast one on Toshiba, because the MGM library helped it to gain critical mass for the Blu-Ray vs. HD-DVD fight. In contrast, Toshiba had defeated Sony in the earlier DVD format war because its ally, Warner Brothers, had pulled the other studio heads together, gotten them to demand a single format, and then written the requirements so that Toshiba's entry was the closest to the spec.

In the early 2000s, many major studios had “independent” divisions: Paramount Vantage, [New Line] Picturehouse, Disney Miramax, etc.  Why did almost all the studio independents shut down after 2008? Because "indie" films produce very lumpy, inconsistent revenue streams. Cable TV sales provided the consistent cash flow to keep them in business. When cable cut back, it was kaput for the golden era of "indie" filmmaking. We really thought that there was a viable business model in producing intelligent movies for the thinking filmgoer without having to scrape by on a shoestring budget – but it turned out to be as solid as the subprime bubble.

Describing the real Hollywood

Epstein’s book The Big Picture, though, was written in 2004, before these recent developments in the film business. It is less topical and more comprehensive in its coverage. For this reason, some parts of the book are rather dull, as when he goes through every single studio one-by-one and tells the story of how it developed into a modern media conglomerate. Many of the moguls, both in the Golden Era and in the modern era, really worked their way up from humble beginnings, with a willingness to bet big. Some, like Sumner Redstone, were so daring in their dealmaking that they had trouble paying back their loans. Rupert Murdoch made substantial cost reductions by indulging in bare-knuckled fights against the London typesetters unions. Many of these episodes start to blur together when collected into a single chapter.  Many many moguls’ lives can you read about in one sitting?

Amidst this encyclopedic recital, though, can be found some real gems of incisive insight. For example, Epstein credits Disney with inventing the modern money-making machine by licensing out the characters. Even in its early days, Disney was already taking in more licensing revenues than box office receipts. Witness the famous Mickey Mouse watch. This explained why Disney was the most willing of the studios to make the leap to television – because its business model had the least to lose from declining box office! This wasn't limited just to the Wonderful World of Disney; he even got Capital Cities/ABC to help fund Disneyland.

Likewise, Epstein’s mastery of detail allows the reader to make connections that would never come out of the capsule summaries that to a large extent pass for journalism. For example, he points out that Universal was hardly being technophobic in going after Sony for Betamax – they actually had a competing playback system in-place at the time: Discovision. Although Epstein then recites the standard spiel about video turning out to be the unlikely savior of Hollywood, we can see that Betamax case really was about the ability to record.

Hollywood accounting

The best chapter in the book is the one in which Epstein explains Hollywood accounting so clearly that you can actually understand it. Screenwriters Marc Norman and Tom Stoppard summarize Hollywood accounting in Shakespeare in Love:

  • Henslowe: But I have to pay the actors and the author?
  • Fennyman: Share of the profits.
  • Henslowe: There's never any!

That's right – your share of the profits will always work out to zero, because the profits will always be zero.  Epstein explains how this can be achieved.

Basically, the big distributors no longer serve the old studio role of putting up the money for the film and taking the risk on earning it back, plus profit. Instead, they are merely clearinghouses for the various entities with financial interests in the film. They presell much of the film to various partners – to to television, to foreign distributors, to production partners. The production costs are thus largely covered in advance, and the studio have only a limited amount of cash at risk.

When the money starts coming in, they then use every trick in the book to avoid showing a profit on the production itself. Gross points are charged against revenues, so any superstar actor with enough clout to negotiate gross points is merely taking money from their fellow actors, who are stuck with net points. Television and foreign rights are block-booked in packages, because these are not subject to the Paramount antitrust ruling that prohibits block booking in cinemas. This block booking then allows the studios to arbitrarily allocate the bulk of revenues to unsuccessful films that are otherwise in the red, preventing successful films from showing a net profit and avoiding payouts to net participants.

The neatest trick in the book is the video royalty, which is set at 20%. This was OK in the 1980s, when a most videos were returned unsold as de facto rentals, but is now wildly unrealistic in a world of sell-through DVDs. The studios thus get to direct 80% of the money towards their home-video divisions (which are not subject to revenue-sharing), and a measly 20% toward the film production itself (which is). Small wonder that some of the most successful films close out their books deeply in the red. The bulk of the revenues have already been sucked out along the way.

A lot of screenwriters complain that they can’t understand studio accounting, but it’s not all that complex once you’ve read Epstein’s explanation. Basically, the studios have complete discretion in their accounting. So the gross participants get screwed as much as possible, and the net participants never get anything, anyway. Screenwriters tend to have the least clout of all the non-salaried participants in a film, so they tend to get stuck with the worst terms.

Aha!  That explains it!

Using Epstein’s framework, we can explain many puzzling aspects of modern-day moviemaking. Why have there been so many recent resurrections of franchises from the 1980s (Terminator, Indiana Jones, Superman)? Because they sell a lot of merchandise and foreign pre-sales have now virtually eliminated the risk capital that once needed to be put in. Recognizable stars like Arnold Schwarzenegger do particularly well overseas and can bring in a particularly large amount of presale money.

Star Wars, Harry Potter, the various comic-hero films -- they all adhere to the "Midas formula": lots of action, lots of special effects, PG or PG-13. Keeps audiences coming in like lemmings, but most importantly – they keep the cash rolling in.

The strange thing about Epstein’s overview is that video is described as relying almost entirely on the afterglow from theatrical advertising. Why is advertising for the video itself so limited, considering that it is one of the biggest profit-centers for the studios? Is this a holdover from the remaining prestige of theatrical exhibition? Or is it a way to avoid drawing attention to video, so that gross participants don't get antsy and and start demanding (as some of the biggest stars have already started doing) a percentage of the actual video revenues? Epstein is great at explaining how things are currently, but does not explain why alternative models cannot get established.

A few strange technical errors mar an otherwise well-researched book. Matsushita certainly did not pay Sony royalties on VHS for "digital sound", because there isn’t any. And why does he keep repeating that CDs and DVDs are six inches in diameter, when they are 120 mm (4.72 inches)? That's almost as strange as his insistence on calling geosynchronous orbit "the Clarke ring." Yes, Arthur C. Clarke did write a famous article about satellites in geostationary orbit, but people involved with space launching and satellite communications simply call it … geostationary orbit.

If you want to really understand the economics of moviemaking, you have to read Epstein.

Note: Epstein wrote a follow-up to this book, The Hollywood Economist, to update industry developments to 2010. Read my review of The Hollywood Economist here.