Economic Analysis for the Motion Picture Industry - Term Paper Example

? . Economic Analysis for the Motion Picture Industry By Candi s FACULTY OF BUSINESS AND MANAGEMENT Executive Summary This very brief report presented a discussion about the economics of the motion picture industry to conclude that box-office revenues for motion pictures exhibit a Levy stable process that is asymptotically Pareto-distributed with infinite variance. Thus, relatively few of the numerous movies produced are box-office blockbusters. However, higher quality productions with a concept with mass appeal, a star cast, good budget, screenplay, effects etc. can become a blockbuster if good word of mouth and reviews propel marketing and advertising efforts. Thus, content is still king and that which appeals to the audience will earn more in an economy with higher levels of affluence and more leisure time. Fixed costs for a movie production house accrue from a need to maintain staff, equipment and stage as well as props in readiness for the shooting and production of a movie. A single movie cannot sustain a production house forever and this means that a successful movie production house is constantly investigating movie concepts, financing, shooting, editing and making deals for marketing and distribution. Variable costs accrue when the shooting of a new movie commences, requiring new stars, talent, equipment or on location shooting. However, after establishing a motion picture production house, the total cost curve and the marginal cost curve for motion picture production will present an L-shaped curve because acquisition of most of the equipment for making movies and stage as well as props etc. is complete at the time of production of the first movie. Contents Introduction 1 Industry Demand 3 Cost Structure 5 Conclusion 9 Bibliography / References 11 List of Figures Figure 1: Income Distribution Snapshot for 100 – 150 Movies showing in Theatres across the USA 2 Figure 2: Shape of Total Cost Curve and Marginal Cost Curve for Production of Television Serial or a Number of Movies 8 (This page intentionally left blank) Introduction Products presented by the motion picture industry represent high levels of artistic innovation that revolve around the product rather than the firm that produces the movie (Vogel, 2007, Pp. 65 – 66). However, although many people think that making movies is fun and highly lucrative, nothing could be further from the truth. Product and demand uncertainty are a part of the movie making business and on the average, out of every ten movies produced, six or seven present unprofitable returns. Thus, making movies remains a truly entrepreneurial endeavour and only those motion pictures that can compete effectively for the attention of the audiences in relation to others present great returns (De Vany, 1999, Pp. 1 – 5). De Vany (1999, Pp. 1 – 5) goes further to suggests that a Levy stable process that is asymptotically Pareto-distributed with infinite variance depicts box – office revenue dynamics for motion pictures, with rare blockbuster movies dominating the mean in the far left end as depicted in the figure below (Sinha, 2005, Slide 10). Figure 1: Income Distribution Snapshot for 100 – 150 Movies showing in Theatres across the USA, from (Sinha, 2005, Slide 10) The film industry presents a myriad of interesting problems that lend themselves to economic analysis (McKenzie, 2009, Pp. 1 – 3). Deciding about a strategy for transforming the initial concept into reality followed by production, distribution and finally exhibition all present economic puzzles that are worthy of investigation. However, with global annual spending on movies by the consumers exceeding one trillion dollars, it is worth aspects related to the economic analysis of the motion picture industry (Vogel, 2007, Pp. xix – xx). This very brief report presents a discussion about aspects of economic analysis for the motion picture industry, including aspects of industry demand and cost structure for the motion picture industry. Industry Demand When thinking about demand for a motion picture, it is important to think somewhat differently from the typical supply and demand model of economics (McKenzie, 2007, Pp. 1 – 5). The demand for a motion picture depends on the signals of product quality that consumers are able to seek from a variety of sources including advertising, reviews, and motion picture trailers as well as shared word of mouth etc. Clearly, production budgets, advertising, awards, reviews, cast appeal or movie star power do present indications about quality of a movie to influence demand, but the sharing of information among cinema goers and viewing audiences presents a stronger impression after a few weeks of the release of a movie. Motion pictures that appeal to a specific segment of an audience, such as kids, adults or adventurous teenagers diminish the total audience size to include only those who are likely present an interest for the subject of a movie. Other factors including price of a theatre ticket, price of a ticket for a segment of population including discounts for students etc., week of run, type and quality of cinema and travel costs associated with travelling to a cinema influence demand and revenues for a movie (De Roos, 2010, Pp. 22 – 24). Audiences prefer relatively new releases compared to movies that have been screening for some time and this means that the capacity of a movie to present peak revenues diminishes with time (De Roos, 2010, Pp. 22 – 24). However, the quality and the capacity to attract audiences will present influences that distinguish blockbusters from the mediocre and the plot, production quality, screenplay, directing, quality of special effects as well as a capacity for touching the emotions often decides about whether a movie will be a blockbuster movie or a mediocre one. New releases that offer substitutes for a movie will diminish the demand for a specific movie (Low, 2000, Pp. 35 – 45). Today, the audience has a wide variety of choices for how they spend their leisure time and disposable income allocated for leisure and recreation (Vogel, 2007, Pp. 3 – 10). Television, radio, newspapers, recorded music, magazines, leisure books, home cinema, spectator sports, cultural events etc. all compete to seek the attention of the audience during their available allocation for leisure. Although the quality of the content I still king, the relative ease with which audiences can now access content diminishes the role of movie theatres even if the relative quality of a specific piece of content maintains attraction. In the present day and age, it is far easier for some individuals to download a movie from the Internet and have a sumptuous meal at home while viewing a great release than to take the trouble to go and view a movie screened at a movie theatre. Although government regulation affects demand for movies in general in complex ways, it is important to understand that a propensity for viewing movies depends on the availability of leisure time and the relative level of affluence of average individuals in a population (Vogel, 2007, Pp. 10 – 23). If an individual is able to work productively in vocations that provide a decent disposable income after providing for basic needs for shorter periods of time every week, the number of leisure hours increases together with disposable income for leisure to increase demand for movies in general. However, underpaid workers who cannot even afford to subsist cannot afford the time or the money to watch decent movies that cost a lot to make. Cost Structure A successful movie production house constantly produces new movies from concept to financing, production, advertising, marketing and distribution of movies (Vogel, 2007, Chapter 4). Thus, in a way, a successful movie production house is in a constant deal making business that will seek to retain copyright for the concept of a production, seek financing for the production of a movie from investors, banks or other sources including government grants and turn this concept into a script and actual movie. After producing a movie, a movie production house will enter into arrangement with distributors / theatre owners / chains for screening and retention of revenue after arranging for proper marketing and advertising of a movie. It is important to understand that any production house cannot sustain itself from only a single movie because the revenues from a single movie diminish and decline over time to present virtually negligible returns over a longer-term horizon. If a movie production house must constantly produce movies, it must have the staff to decide about film concepts, the props and the production equipment to shoot, edit and to incorporate special effects into a movie (Vogel, 2007, Chapter 4). A movie production house must retain financial analysts, marketing agents, accountants, camera operators, editor, press and public relations staff etc. on an on-going basis for on-going movie production activity. Thus, a movie production house incurs fixed costs associated with retention of essential staff, film maintenance of production and editing equipment, maintenance of properties for shooting and props for stage etc. Fixed costs for a movie production house will depend on the quality of movies desired, with higher fixed-costs for those production houses that are likely to produce full-length movies with special effects and complex animation on an on-going basis. However, lower fixed costs are likely for those production houses that want to present soap opera serials or perhaps even sex movies that require relatively simple stage, readily altered to suit. According to Vogel (2007, Chapter 4), after approval of a concept for production into a full movie, variable costs will accrue in the form of budget for any shooting on locations, payment for leading actors and extras, together with costs of costumes, special stage and props for shooting, special equipment for film editing / shooting or special effects etc. Payment will be required for film directors while they are working on a movie project and every film will require marketing and advertising prior to its release to enhance its chances for success. Thus, broadly speaking, variable costs will accrue depending on the specific requirements of a project for production of a movie. Generally, a high quality movie will incur higher variable costs. The shape of a movie production firm’s total cost curve and marginal cost curve is generally an L – shaped curve because acquisition of most of the equipment and other necessities for making films, including the equipment for making films together with the props and the stage etc.is completed after the making of the first movie. Thus, the second and subsequent movies will attract lower incremental costs to present an L-shaped curve (Bourreau, 2002, Pp. 29) and (Department of Economics, Brigham Young University, 2011, “Economies of Scale”). A depiction of typical L-shaped total cost curve and marginal cost curve shape for a series of episodes for a television serial or a series of movies in a production house is below: Figure 2: Shape of Total Cost Curve and Marginal Cost Curve for Production of Television Serial or a Number of Movies, from (Bourreau, 2002, Pp. 29) Conclusion It is clear from the discussion presented in this very brief report that the production of movies and the motion picture industry present many economic puzzles worth investigating. However, an established motion picture production house with the right talent can continue to churn out quality to remain competitive if managed properly. (This page intentionally left blank) Bibliography/ References Bourreau, Marc. Gensollen, Michel and Perani, Jerome 2002, Economies of Scale in the Media Industry, Department of Economics, Telecom Paris Tech France Research Paper, retrieved: July 3, 2011, from: http://www.gensollen.net/scale.pdf De Roos, Nicolas and McKenzie, Jordi 2010, ‘Cheap Tuesdays’ and Estimating Movie Demand: An Empirical Analysis of the Australian Cinema Industry, Department of Economics, University of Sydney Research Paper, retrieved: June 2, 2011, from: http://www.econ.mq.edu.au/Econ_docs/research_seminars/2010_research_seminars/2602_CheapTuesdays_McKenzie.pdf De Vany, Arthur 2004, Hollywood Economics: How extreme uncertainty shapes the film industry, Routledge De Vany, Arthur and Walls, David W 1997, The Market for Motion Pictures: Rank, Revenue and Survival, Economic Enquiry, Vol. XXXV, October, 1997, Pp. 783 – 797, retrieved: June 2, 2011, from: EBSCO De Vany, Arthur and Walls, David W 1999, Uncertainty in the Movie Industry: Does Star Power Reduce the Terror of the Box Office? 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