The Price To Save Hollywood Blockbusters

That’s it, this is the final straw. I can’t hold my tongue much longer….Ben Hur? Really?

If you’re an avid moviegoer like me, you likely noticed the critical and financial let-down that was the Summer 2016 Box Office. From boring re-makes, to unoriginal sequels, this summer was frustrating and disappointing for all cinephiles and movie buffs. But why exactly do we feel so dissatisfied? Maybe because we expected more for the high price of admission.

In this article, I want to propose a potential solution to avoiding box office disappointments like the one we just had. While “better films” may seem like the logical cure, I believe box office under-performance can be mitigated by simply aligning with consumers on expectations. Studios should consider dynamic pricing for movie tickets to capitalize on consumers’ willingness to see a film. To optimize the demand pricing model, studios will need to raise their level of awareness of the consumer’s opportunity cost of going to see a film at the movie theater.

The Numbers

So why exactly was this summer such a disappointment? Let’s first examine the numbers. The domestic box office returns are the worst they’ve been in past 4- years and are down over 10% when compared to last year’s summer (see Figure 1). Sure, some years will be better than others and one can argue that 2017 will rebound like 2015 did after 2014. However, 2016 is alarming because it may signal the end of the blockbuster business model.

Figure 1

The Summer Blockbuster

The term “blockbuster” in entertainment refers to big budget movie productions that attract large audiences. For the past century, Hollywood has relied on massive productions to bring in the most ticket sales. The reason being is that huge-scale films have typically attracted larger audiences with a promise of cinematic spectacle.

Movies like Gone With The Wind, Ben-Hur and Cleopatra may be considered among the first blockbusters of the industry but it was Jaws (1975) that created the modern summer blockbuster as we know it today. Its wide national release supported by blitz advertising created the first ‘event movie’, broke office records and became the template for later blockbusters including Star Wars (1977), Raiders of the Lost Ark (1981) and E.T. The Extra-Terrestrial (1982).

Thus, the summer blockbuster business model was born. Summer blockbusters were to bring in the most amount of revenue for a studio because the larger the production, the bigger the audience. Hence, why modern summer blockbusters are often referred to as ‘tentpole movies’ as they represent the most important products in a studio’s release calendar.

Yet, does the blockbuster business model still work? Do larger production budgets equate to larger revenues and if so, do these films actually return profit? To address these questions, I’ve examined the summer box office for years 2013–2016. I’ve chosen to isolate the sample size to these years due to (1) the availability of data and (2) the evolving abundance of substitutes not present in previous decades (YouTube, Netflix, Instagram, Pokemon Go, etc).

Let’s first examine the domestic performance of the top 10 most expensive summer films for each of the past 4-years (see Figure 2). For years 2013–2015, we see that, in aggregate, the top 10 films do break-even, with 2015 achieving the highest return on production investment of 47%. While the relationship is not perfectly linear (revenue vs. investment), studio execs have been confident that big budget productions will return, at minimum, the same amount that was initially invested on average.

Then we move to 2016, which saw the top films produce the lowest return on investment with an alarming -14%. In fact, only two of the top 10 movies of 2016 reached profit and only one of them received a “fresh” rating by Rotten Tomatoes.

Figure 2

From a gross total view, each of the summers did break-even, with 2015 again being the top performer (ROI of 45%) and 2016 again being the worst (ROI of 6%). But can we be sure that 2016 actually made money? Studios are typically sensitive about disclosing the non-production costs for films: marketing, print, manufacturing, overhead, etc. Stephen Follows, a notable film industry researcher, found that films with an average production budget of $150 million also incur additional non-production costs of $260 million on average (see Figure 3). Using Stephen’s analysis as a benchmark, it is likely that 2016’s total ROI may in fact be negative from a domestic view. As a result, 2016 may have broken the model that big budget productions return the amount invested or more.

Figure 3

Hey, but what about China? True, the argument can be made that Hollywood can still rely on international markets to drive positive returns as seen in the Figure 4. Yet, 2016 still under-performed relative to previous years despite being the 2nd most expensive production size of the sample set. The top 10 most expensive films of 2016 returned only $4.3 billion for international gross which is 24% lower than 2013 and 37% lower than 2014 and 2015. The overall gross for 2016 also trailed previous years by 30–40%. In additional, 2016’s return on investment for both the top 10 and overall gross also trailed the performance of past summers. Therefore, studios may need to question if the blockbuster means what it used to.

Figure 4

At last, if 2016 marks the end of the blockbuster era, what were the reasons that led to its demise? Everyone has a plethora of explanations, but there are two reasons we can all likely agree upon. First, unwanted sequels are flooding the theaters and drowning any chance of new creative art. Studios have a limited budget so the financing of every sequel comes at the expense of another original film not being produced. In aggregate, audiences and critics did not respond to sequels very positively. X-Men: Apocalypse, Huntsman: Winter’s War, Alice Through the Looking Glass, Neighbors 2: Sorority Rising, Independence Day: Resurgence, and Now You See Me 2 all under-performed at the box office. Second, audience appetites for remakes appears to be nonexistent, with films such as Ben-Hur and Ghostbusters bombing at the box-office. Ben-Hur took $22 million globally although it cost a staggering $100 million to produce. Similarly, Ghostbusters saw a negative domestic return, grossing about $124 million on a $144 million budget.

So is the summer of 2016 an outlier or is it a signal to the end of the blockbuster business model? Lets assume the apocalypse; studios may no longer be able to rely on big budget films to return the large scale revenues needed to make profits in today’s entertainment ecosystem. But while the Hollywood blockbuster may be in jeopardy, I believe there is a potential answer for its salvation. While “better films” may seem like the obvious fix, I would like to propose a more analytical solution. I believe the answer lies in understanding the “See Movie” Theorem and adopting a dynamic pricing model.

The Price of Admission

At my local AMC River East 21 in Chicago, IL, the evening ticket is $12, plus taxes for a standard 2D showing. Yes, senior rates and matinee discounts exist, but my movie theater does not offer different prices for different films showing at the same time. Therefore, whether I see the $175 million superhero juggernaut that is Suicide Squid or the $4.9 million bootstrap horror film Lights Out, the Fandango Check-Out cart still reads the same: $13.43. So why is it that I must pay the same price for two very different movies? Why is it that a movie with my favorite actor (Will Smith), favorite source material (superhero) and favorite genre (action/adventure) costs the same as some low-budget, horror flick? For comparison, it appears that I’m paying the same price for a Filet Mignon vs. a Happy Meal.

On the surface, it seems that this uniform pricing model favors lower budget films at the expense of costly blockbusters? Not exactly. By eliminating ticket pricing from the decision making process, consumers are forced to put larger weight on other factors impacting their decision to see a film. This brings us to my “See Movie” Theorem.

The “See Movie” Theorem

Think about the process that you go through when deciding to go to the movie theater (see Figure 5). When determining whether to go see a movie, rarely do we factor in the price of the movie ticket because we know it is irreverent at that point-in-time.

Figure 5

I believe the decision making process for seeing a film in the theater can be broken down into a simple formula I call the “See Movie” Theorem (see Figure 6). First we want to know the Cost of Investment (COI) for seeing the film (i.e., the level of effort and opportunity cost required to see the movie). My COI is simple: COI = (1) time/effort to drive to the theater + (2) cost of paying for overpriced snacks + (3) willingness to sit in a chair for +2 hours + (4) time/effort to drive back home. The COI only increases with the presence of attractive substitutes such as Netflix, the Olympics, DJ Khaled Snapstories and Pokemon Go to keep me busy.

That brings us to the next part of my equation, the expected Return on Enjoyment (ROE) from seeing the movie (i.e., the reward and satisfaction I will likely get from viewing the film). As such, my ROE constitutes the following: ROE = (1) rotten tomato score + (2) word-of-mouth + (3) infatuation with actor(s)/director/source material + (4) fear of missing out.

Figure 6

So when exactly do we make the decision to see a movie? When the ROE > COI. As a result, the quality of the film is extremely important. If we examine Figure 7, it’s no coincidence that there appears to be a positive correlation between a film’s financial success and positive critic reviews. The power of critic reviews on box office performance is so well-known that fan bases have threatened reviewers in the past for their negative reviews (see TDKR or Suicide Squad).

Figure 7

By that logic, it seems that better screenplays, popular source material and talented artists are most important for producing a successful film. I don’t think so. I think the key is to understand the ROE and COI of your target audience and price appropriately. Let’s look at two examples:

  • Warcraft: Warcraft first began as a popular video game franchise that launched in 1994 and is still active today with millions of players worldwide. I’m not a Warcraft player but I did believe the movie had massive potential. With Duncan Jones directing, ILM producing the innovative effects and 10 years of marketing build-up, Warcraft absolutely had my attention. Then the reviews came out… With a score of 28% on RT, my COI was just too high for this film.
  • However, if I was one of the +3 million U.S. Warcraft players waiting years in anticipation for the film, my ROE is likely to have been much higher. To me, the reviewers simply don’t understand the film. The opportunity to see the characters, story and lore I love brought to life on the big screen is a no-brainer movie going decision. For these passionate fans, movie studios fail to capitalize on their greater willingness to pay by holding pricing constant. By raising pricing, studios can leverage the price-insensitivity of Orc and Night elf lovers to offset the loss of volume due to the average movie viewer. The result is a higher top-line that is less dependent on volume and priced efficiently.
  • Adam Sandler: Adam Sandler has built a reputation of creating low brow, highly criticized films this past decade. Why is it then that Netflix inked a pact with Sandler to star in and produce four films to be available exclusively on Netflix worldwide? Because Netflix understands the COI of their audience.
  • My COI for Netflix is very low. With a $8 — $12 monthly subscription, I have access to a library of content, including the new Sandler films. Therefore, the incremental cost per film watched is $0. In addition, Netflix allows me to watch when I want and where I want. Therefore, gone are all the major pain points of going to the theater. As a result, my COI for a Netflix Sandler film is so low that even the smallest of ROE guarantees I will still watch the film. And I am not the only one with a low COI for Sandler films on Netflix. Adam Sandler’s debut film for Netflix, the western-themed comedy The Ridiculous 6, debuted to the highest-ever opening viewing figures in the streaming service’s history last year. However, I’m curious to know how those numbers would change with an increased COI? Imagine if viewers were constrained to Netflix’s DVD-by-Mail model; limited to 2–3 movies per rental and needing to wait 1-week for delivery. My guess is that the higher COI would result in less viewings for the Sandler film.
  • So how can theaters leverage Netflix’s Sandler-nomics? By potentially lowering the price of the next Sandler film in theaters. With a lower price point, viewers are more likely to justify the investment of going to see a Sandler comedy and therefore, lower their COI. Sure, some of the pain points for going to the theater still exist, yet they are more justifiable with lower pricing. If I’m in the mood for a comedy or am a Sandler fan, my COI is further decreased if I feel like I’m getting a value deal. Finally, because my expectations for the low-priced film are set to a more reasonable measure, I’m less likely to be disappointed after the viewing. The result is a greater amount of positive word-of-mouth to my friends, increasing their ROE.

Takeaways

So why haven’t movie studios experimented with dynamic pricing? Well for starters, pricing a product/service is very hard. It requires a lot of experimentation, accurate sales data and strong customer relationships. Therefore, creating unique pricing at the “per-film” level is a challenging endeavor. Second, consumers are smart and know how to work the pricing game. For example, imagine if theaters consistently cut prices after a successful opening weekend. If people knew that ticket prices would fall after a big opening, many more would wait until the second or third weekend to see it, destroying the meaning of “opening weekends”. If theaters were to show different movies at different prices, consumers may also buy fake tickets to their show to sneak into the more expensive blockbuster.

Therefore, I’m sure Hollywood has spent a tremendous amount of effort in analyzing the “bugs” of a dynamic pricing model. However, if box office investment is no longer correlated to box office returns, Hollywood will need new strategies to return profits. They can either stop making bad movies or consider new strategies to pull the levers of the “See Movie” Theorem, one of which may be dynamic pricing. So which one is easier, dynamic pricing or quality film making? My hope is the latter.

What do you think? Please feel free to leave a comment with your thoughts and opinions on the movie business. Thanks for reading!

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