Industrial Economics: the American Motion Industry 2000-2008 - Report Example

The American Motion Industry 2000-2008 Your Name Goes Here Name of University Here Synopsis In 1948, the US Supreme Court made held that the operations of eight of the country’s major motion picture studios were in violation of the 1890 Sherman Antitrust Act.1The Court’s decision meant that the Studios were to make a clear distinction between producer and distributor roles from cinemas. It was believed that by doing so, competitive practices would be promoted in the industry. However, this decision negatively affected Hollywood’s supply chain, leading to its collapse. However, Hollywood has continued to grow significantly with firms reaping billions of dollars in revenue. This research analyses market structure for the film Studios using measures of industrial concentration and inequality and compares the performance of the major studios over the 2000-2008 periods. In addition, the research establishes the degree of risk entailed in film production and distribution and how this changes over the period under study. Finally, the paper assesses the function of studio portfolios in attenuating risk. Dominance of Hollywood Hollywood has continued to dominate the world markets; it has been difficult for European companies to catch up. It is important to note that this dominance has been confined to a few firms, which enjoy more than 90 per cent of market share. The dominance of US film Studios can be attributed to the sharply rising film production costs- which are more of fixed and sunk, thus the market size become an essential factor in determining the amount of money that could be spent on the production of a film. Thus, the market size has always been complex and new entrants found it hard to gain market share, first due to war, and later due to protectionism. The market size was also negatively affected by heavy taxes on cinema tickets that raised the price of cinema relative to live entertainment. However, after the ruling on the1890 Sherman Antitrust Act, the Court’s decision meant that the Studios were to make a clear distinction between producer and distributor roles from cinemas, encouraging competitiveness. The emerging Hollywood studios benefiting from first mover advantages in feature film production expanded their international distribution networks, and could afford to offer cinemas large portfolios of films at a discount (a technique known as block-booking), and sometimes even before the films were made (blind-bidding). In addition, the quality gap with European and Asian film features has remained to be relatively large. Finally, since the 1990s, the American origin of the feature films had established U.S. films as a brand, this left consumers with high switching costs to experiment on films from other countries. Thus, emerging companies (domestic and abroad) found it to be extremely costly to re-enter global distribution, produce large portfolios, establish film quality, and build a new brand of films, simultaneously (Bakker 2005). Industry Concentration The concentration ratio is the percentage of market share of the largest m firms in a given industry. This research assumes m = 4, and is expressed as: CR4 =  s1 +  s2  +  s3  + s4 Table-1: Concentration Ratios, Hollywood Studios Year CR4 2000 52.12 2001 48.15 2002 52.16 2003 53.86 2004 59.85 2005 52.75 2006 62.32 2007 57.54 2008 58.68 In general, the CR4 measure is more than about 40 (indicating that the four largest firms own more than 40% of the market), therefore the industry cannot be considered to be very competitive. There are other firms but only a few of other firms are competing, and the bigger chunk of the market belongs to few firms. An important factor that limited competition to a few firms was the ascendancy of Hollywood as production location. Looking at the revenues data from 2000-2008, large existing American Northeast coast film industry and those that were newly emerging in Florida declined as most companies started to locate in Southern California. Firstly, this was to allow for the sharing of inputs and to benefit from knowledge spillovers, allowing for higher returns. The major studios were able to lower costs because their creative inputs were used more efficiently, costs of travelling were lowered and they could participate in more try-outs to attain optimal casting. In addition, major studios had the ability to be rented out easily to competitors when not in immediate demand. These Studios also attracted new creative inputs that were non-monetary in nature: the inputs were after even fame and professional recognition. For instance, an actress could not decline an offer to work with the world’s best directors, designers, sound and light specialists as well as make-up artists. Secondly, a rich market for specialized supply and demand was in existence. Major Studios could easily rent out excess studio capacity. Even with a relatively higher overall cost/quality ratio, Hollywood was not an easy industry to enter (Krugman and Obstfeld 2003, chapter 6). And in cases where entry took place, as it did happen, the Hollywood’s major studios could and were able to purchase successful creative inputs; they could effectively realize higher returns on these inputs. This resulted in the favor of films from major Studios, due to perceived higher quality, thus perpetuating the situation. Nature of Demand Motion pictures are in general classified as products for which demand forecasting is unclear. It follows that the film industry is competitive, but limited to a few firms and its structure is believed to exhibit demand uncertainty and is unlikely to be Pareto efficient. The variations in the Studios’ revenues are measured by cumulative distribution and revenues are not converging to a long-term average-the confidences are without bounds. However, this variation is not very large; this can be attributed to the limited cross-section data that focuses on only the major Studios. It is empirically clear that Studio revenues did not show a central tendency – not even for the top well performing Studios. An overview of Global Competition Looking at the recent trends in some countries, for the period from 2002 – 2007; competition from Eastern Europe and Asia increased substantially. Competition from outside the West was experienced from countries such as Japan, Hong Kong, India and China. The Russian film industry increased by 80%, while the Chinese box office edged by 75%. Similarly, box office of countries such as Brazil, Czech Republic, Poland, Argentina and Ireland grew by about 50%. Other substantial growth rates over the period 2002 – 2007 were also experienced by Australia, UK and Canada which grew by 39%, 31%, and 23% respectively. On the other hand, the U.S box office declined by 8%. The slump in the share of U.S. box office of the global box office can be attributed to a myriad of factors, such as differences in population growth rates, types of economies (mature and developing), income growth rates and the relatively fast increases in movie ticket prices outside the U.S. Characteristically, another important trend is the Studio market share by country of origin in global markets. For instance, looking at the European Union from 1999 – 2008, there was a significant fall in the share of films released solely by U.S. Studios. European film admissions for films originating in the U.S. fell from to 53% in 2008 compared to 70% in 1998. There were also significant increases in theater admissions in the EU for films produced in the US, France as well as for films produced in other European countries. An important trend to note is that, in 1999 U.S. films enjoyed double the French box office market share of local films in France. On the contrary, by 2008 the market share of French produced films had overtaken U.S. productions. Comparable trends could be noted in Italy, Germany and the U.K. Here, US and EU co-productions significantly rose from 4% in 1998 to 17% of in 2008. In other countries, for the most part in Asia, locally produced films take a large share of the total box office. In Japan, the revenues stood at $803 million making it the second-top performing market in terms of revenues. This means that local films accounted for 48% of the Japanese movie market. Correspondingly, local films in South Korea accounted for 45% of market share. However two countries potentially dictate the Asian region: China and India (Bakker, 2008). The Economics of Film Trade Since film production costs were basically fixed and sunk, supranational sales or distribution played a key role on the revenues of film Studios. These were marginal sales without significant additional cost to the producer; the film had already been produced. Film production involves relatively high endogenous sunk costs, recovered from renting the copyright to the film. This meant that marginal foreign revenue was matched to marginal net revenue, thus all companies large or small had to seriously consider foreign sales when projecting their revenues (Bakker 2004b). Films were intermediate products sold by US Studios to foreign distributors and cinemas. The rent paid depended on the perceived quality and general market conditions (supply and demand). The ticket price paid by consumers has generally remained to be invariant. It possibly varied by cinema: highest in ultra-modern city center cinemas and lowest in suburban neighborhood cinemas. Because film is in itself an intermediate product and a capital good at the same time, international competition could not have been based on price alone. For instance, consider a film’s selling capacity to be proportional to production costs, it is difficult for a low-budget producer to simply lower a film’s rental price in line with its quality so as to increase sales; even at a price of zero, it is clear that some low-budget films could not be sold (Sedgwick, 2002, p.680). There are two main reasons behind this argument. First, most cinemas have high fixed costs and low variable costs, thus, a film’s selling capacity ought to at least cover fixed cinema costs and rental costs. For instance, a five-hundred-seat cinema, with a production capacity of 20,000 spectator-hours a week, weekly fixed costs of four hundred dollars, and an average ticket price of five cents per spectator-hour, needed a film selling at least eight thousand spectator-hours, and would not be willing to pay for that additional film, because it only covered fixed costs. Practically, films must meet a minimum selling capacity to allow cinemas recoup fixed costs. Assuming that a film’s selling capacity is known ex ante, producers could only lower low-budget films to just above the minimum level, pricing any lower than that can imply that these Studios could not sell their films at any price (Gomery, 2005, p.23). Uncertainty in the film markets A key feature distinguishing foreign markets from domestic was that uncertainty in the domestic market is relatively lower: from the time of launching in the domestic market the audience appeal is considerably known, and each subsequent country added more complexity. Even though a film’s audience appeal across countries did not exhibit perfect correlation, uncertainty was significantly reduced. For most of the major companies, correlations between foreign and domestic revenues for the whole film portfolios ranged between 0.60 and 0.95 (Bakker 2004b). Given that film production is a highly risky activity, this reduction in uncertainty undeniably was significant. A second reason for restricted price competition in the film industry can be attributed to the opportunity cost, as based on cinemas’ production capacities (Vogel, 2004). Low-capacity film with say a half selling capacity of the high-capacity film might need to be priced at less than a fifth of the price of the high capacity film to be accepted by cinemas. This might mean that a low-capacity film may not be able to cover production costs. This evidence of sharply increasing returns to selling capacity significantly influenced the revenues and setting of production studios, as having the right price/capacity ratio was critical for winning foreign markets (Caves, 2000, p. 135). Conclusion The rise and development of the film industry in the early 20th century had been mainly by influenced by the changes in demand. Film Studios have industrialized entertainment by homogenizing it, and making it tradable. Years after the ruling by the US Supreme Court, regarding the Sharman’s Act, the industry has experienced a quality race leading to increasing industrial concentration. The film industry experienced vertical disintegration at some point, leading to more flexible and enhanced specialization of production, and a fully-fledged process of increasing distribution channels, production capacity and market growth. Increased competition in the film industry has led to industrialization of entertainment, and the creation of a series of international industries such as Cinemas that offer entertainment services. The advancement of the film industry in particular film Studios may give insight into the effect of technological change and its companion welfare gains in many service industries that are yet to come. Bibliography Bakker, G, 2004, "Selling French Films on Foreign Markets: The International Strategy of a Medium-Sized Film Company." Enterprise and Society 5, pp. 45-76. Bakker, G, 2005, "The Decline and fall of the European Film Industry: Sunk Costs, Market Size and Market Structure, 1895-1926." Economic History Review Vol.58, no. 2, pp. 311-52. Caves, R. E, 2000, Creative Industries: Contracts between Art and Commerce. Cambridge, MA: Harvard University Press. Gomery, D, 2005, The Hollywood Studio System. London: MacMillan/British Film Institute. Krugman, P, R., and Obstfeld, M, 2003, International Economics: Theory and Policy (sixth edition). Reading, MA: Addison-Wesley. Sedgwick, J, 2002, Product Differentiation at the Movies: Hollywood, 1946-65." Journal of Economic History vol. 63, pp. 676-705. Sedgwick, J, and Pokorny, M, 2004, An Economic History of Film. London: Routledge, 2004. Vogel, H. L, 2004, Entertainment Industry Economics: A Guide for Financial Analysis. Cambridge: Cambridge University Press, Sixth Edition. Bakker, G, 2008, "The Economic History of the International Film Industry". EH.Net Encyclopedia, edited by Robert Whaples, viewed May 6, 2010 from http://eh.net/encyclopedia/article/bakker.film Read More