Overview of the Film Industry
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The film industry consists of two principal activities: production and distribution. Production encompasses the development, financing and creation of feature-length films. Distribution involves the promotion and exploitation of films throughout the world in a variety of media, including theatrical exhibition, home video, television, cable, pay-per- view, satellite, DVD, Internet and other ancillary markets. Failure to adopt tight cost controls at any one stage has obvious adverse budget implications. Failure to adopt tight cost controls in the early phases of production will compound the problem in later phases. API selects scripts during the development phase to reduce the dangers of cost overruns in the later production phases. API will select each project based solely upon the anticipated revenues from the overall salability of the film and not on the subjective taste of the producer.
Film Development and Production
The production of a film occurs in four distinct phases prior to initial release: development, pre-production, principal photography and post-production. During the development phase, the producer generally acquires the rights to a novel, story or screenplay or develops the story internally, and finances the writing or the revision of the screenplay.
After a screenplay has been approved for production, the project enters the pre- production phase. During pre-production the producer will engage creative and production personnel, obtain insurance, plan shooting schedules, establish locations, secure any necessary studio facilities, finalize the budget and prepare for the start of actual filming.
After financing is put in place, the next phase is principal photography. This usually takes 21 to 90 days to complete, depending on such factors as location, weather, budget, special effects or other unique requirements of the screenplay. Following this, post- production commences. The film is edited: music, dialogue and special visual effects or audio effects are added, and the voice, other effects and music are synchronized with the photography. The producer utilizes the resulting film negative to create the prints to be released to cinemas.
The producer (either directly or, in most cases in the independent film production sector, via its duly appointed agent) enters into agreements with distributors to distribute the film in designated film markets. The producer and distributors will then develop marketing campaigns and advertising budgets in preparation for the theatrical release of the film.
Film Distribution and Exhibition
Distributing and exploiting films in various markets throughout the world, pursuant to customary release patterns or "windows," generates revenue for films. These windows include domestic and international theatrical exhibition, non-theatrical venues (which include airlines, military installations, hospitals and hotels), home video, U. S. television (including pay-per-view and pay, network, syndication and basic cable) and other ancillary sources such as consumer products, themed entertainment, and publishing, DVD, Internet, other "new media" and music soundtrack sales.
While the timing of revenue received varies for each film, a substantial part of the revenue generated by a film is usually received within the first three years of a film's life, with the majority of such revenue being received within the first 18 months of a film's initial distribution cycle. There are substantial time lags between the receipt and onward transmission of revenues from exhibitors to distributors, from distributors to producers, and from producers to investors and third party participants. Investors in the production do not normally see any cash flow before a minimum of two years following the release of the film for distribution unless a film is a significant success.
Producers' Net Profits
Gross receipts include all proceeds from distribution and exploitation of the film in any existing and future medium. From these gross receipts the sales and marketing agent's fees and expenses are deducted. Next, the providers of finance and investors in the film are entitled to recoup the amount of their investment plus interest and other agreed financing costs. Further payments may be made to a completion guarantor if there has been a cost overrun. Finally, payments are made to entities involved in the production process that have agreed to accept deferred payments. Payments accruing to the Producer, following the deduction of the above sums and any other deductions, are termed "Producer's Net Profits." This is the level at which the investors may participate in the profits of a film, although the amount and definition of "Producer's Net Profits" will vary on a film - by - film basis.
Source of Revenue
Gross box office receipts are shared between the territorial distributor and theatre owners. The distributor's share of box office receipts is referred to as "theatrical rentals." Box office splits are determined on a film-by-film basis with each exhibitor and are often negotiated based on the box office performance of the producer's prior releases. Although these shares vary widely, on average the split between exhibitor and distributor is 50/50 over the length of the theatrical run.
The principal expenses related to theatrical release are print and advertising ("P&A") costs. Print costs are incurred for duplicating the negative into prints that will be sent to theatres for actual exhibition. The processing and distribution of prints depends on the number of screens on which it is initially exhibited. A certain amount of advertising costs are incurred during the two months preceding the theatrical release of a new film, with the majority of advertising costs being incurred just prior to or on release of the film. Advertising costs include the production and placement of print advertisement in international markets. Technological developments have developed and resulted in the availability of alternative distribution media for film entertainment, including expanded pay and cable television, pay-per-view, DVD, and the Internet.
It is difficult to be specific about the likelihood of success of a particular film or library of films. Indeed, there are no dependable rules of thumb that provide a guide to making revenue projections for films. However, there has been ten consecutive years of box office growth throughout the world.
Internationally, box office generally represents less than 25% of the total revenue from film distribution. The 'rule of thumb' for distribution revenues is that box office accounts for approximately 22.5% of total receipts, DVD for 55%, and broadcast, pay, cable, syndication, satellite and all other rights for the remaining 22.5%.
The Future
1 Box Office
Multiplexing and a strong consumer economy can be expected to continue to boost box office revenues throughout the world. The number of screens is growing every year.
2 Television
Television markets have considerable room for growth, especially in Third World markets. Free to air channels have been joined by cable and satellite subscription channels that have significant scope for market penetration. Digital television technology means that the home theatre dream is an imminent reality. This market will become increasingly important as digital receivers become less expensive over the next several years. These sets will double as computer screens and provide a complete entertainment, information and educational experience.
3 Home Video/DVD
In the USA, moviegoers spent two-and-a-half times as much money buying and renting home videos in 2002 as they did at the box office. The home viewing preference is forecast to grow even more pronounced by the year 2005 as spending on DVD, fueled by explosive growth in movie purchases as opposed to rentals, increases at 9.1% compound annual rate over the next 5 years. The penetration of DVD players into homes throughout the world continues at a spectacular rate.
Digital - DVD and the Internet
The DVD and Internet markets are becoming increasingly important as digital television receivers and players will become less expensive over the next several years. Digital technology means that the home theatre dream is an imminent reality. These sets will double as computer screens, so Internet delivery of movies "on demand" could be accessed by every home with an Internet connection.
These new digital technologies are set to alter the release pattern windows for film. Until recently, a film would appear in the home video market within 6 months of its theatrical release; 6 months later it might have appeared on the premium pay magazines and trade publications, television, radio, billboards, and the production costs of fifteen-second to two minute trailers, as well as various publicity and promotional campaigns. Advertising costs to "open" a film (i.e. expenditures incurred to drive awareness of a new film release) are significant and, for a widely released film, may be more than half of the total P&A budget. Although theatrical rentals alone may not justify such expenditures, creating brand identity and awareness for a particular film fosters sales in subsequent release windows, particularly DVD and television.
In addition to the revenue from theatrical release, films may generate revenue that, ultimately, the Producer and Investors may share in by the way of:
Ancillary Rights
Music from the film may be licensed for sound recording, public performance and sheet music publication. Rights may also be licensed to merchandisers for the manufacture of products such as video games, toys, T-shirts, posters and other merchandise. Rights may also be licensed for novelizing the screenplay and other related book publication.
2 Non-Theatrical Rights
Late in the domestic theatrical run, a distributor may license the film for non-theatrical exhibition to distributors who make the film available to airlines, ships, military installations and other governmental institutions.
3 Home Vidoe/DVD
A film may be distributed to the home video market utilizing a rental or sell-through strategy. Most of the films are distributed using a rental strategy whereby video cassettes and DVD's are primarily sold to video retailers for rental to members of the public, with the manufacturing of cassettes/DVD's and trade marketing as the principal costs incurred by the distributor.
A sell-through strategy is chosen based on genre and a film's theatrical performance when a producer believes that the number of cassettes/DVD's sold directly to consumers (either in addition to or in place of those sold to video retailers for rental) will generate profits that will exceed those generated under a rental strategy.
4 Pay-Per-View, Pay and Free Television
Television rights to films are generally licensed first to pay-per-view in the USA (the UK, Australian, German, and other countries' pay-per-view market is only now starting with the recent launch of digital television) following or concurrent with home video release, then to pay television followed by network broadcast television and finally to local broadcast stations or basic cable networks. Producers license their films to pay television networks for a fee based primarily on the film's theatrical performance or to pay-per-view networks for a fee based on the number of consumers who elect to view the film. Free television means the license of the film to terrestrial television (e.g. CBS, NBC, ABC, PBS, BBC, etc.), which is available to the public without payment of a fee or subscription.
Revenue and Costs Trends
The film industry has diversified its revenue sources and grown substantially as a whole in the past two decades, primarily due to technological developments. The film industry is the second biggest international export on the global market second only to arms manufacturing. The movies projected budget is constant and locked.