Cook The Books

Ahh those Hollywood Accountants. They just make up numbers to mess with poor, naive, innocent little actors and actresses…

Brad Pitiful is making a movie about an alien who comes to earth and gets elected president. Brad gets 10 percent of the movie’s profits as compensation. The flick is a blockbuster, uh...monster hit, doing 200 million at the box office and another 100 million in licensing revenues from Netflix, the networks, YouTube, and the like. Brad has his eye on a shiny new G6 jet, and is all set to buy one when the studio says, "uh, sorry...no profits."

"Um...how can this be?" he wonders.

The studio accountant, Lucky Jim, does the math.

Well, the 200 million was just box office sales. The theaters keep half the money, so that’s 100 million for Brad. Same deal with the after-market 100 million...50 million for Brad.

And he says, “But that’s 150 million. Don’t I get 15 million of it?”

Uh...no. Small thing called production cost. The studio needed to actually make and then market your movie. It cost 80 million to shoot and 30 million to market.

Brad sighs, thinking about a much smaller plane. “Well then, ok...that’s 150 million with 110 million in expenses...so the movie made 40 million, and I get 6 million, right?”

Uh...not so fast. That 80 million wasn’t spent the day before the movie rolled out into theaters. It was spent years beforehand. And renting money costs…money. So the studio had to use its credit, i.e. rent money from banks and partners to fund the movie’s production. It had borrowed 80 million bucks for 5 years, in fact, and then another 30 million for 2 years to market it. Now, this is extremely risky capital. If the movie had bombed, then the banks might have lost everything.

So if you were the bank, would you charge just 3 percent for that extremely risky capital? No way. And the studio could have rightly told the producer to go fund it elsewhere...get whatever interest rate on the money she could find, and the studio would match it, and surprise surprise...there were no takers. Not a single lender was willing to take on such enormous risk, even at a 20% interest rate. So the studio "generously" loans the production money at 15% interest.

15% on 80 million for 5 years? That's 12 million of interest per year for 5 years, or 60 million total. And that 15% was a gift. The market price was more like 20%. Then 15% on the 30 million for two years to market it? Add another 9 million in interest costs.

So what happened here? The interest charges ate up all the profits. Yes, the film had operating profit, ignoring interest costs, of 40 million bucks. But it had to rent the money to go make the film. The rental cost or interest cost of the money was 60 million for the production and 9 million for marketing.

Oh, and there’s this other little thing called a distribution fee that studios take in return for pushing the film into the difficult-to-deal-with theater owners. And usually that’s 30% off the top. But those are details.

So...were the books cooked here? No. If making movies was such an easy, profitable business, there would be legions of venture capitalists throwing money at the business the way there are in Silicon Valley with computer software engineers.

Unfortunately, Hollywood’s heyday was a half-century ago, and economically, it’s dying. The studio (and banks behind it) have to charge a very high interest rate to accommodate for the sad fact that most movies don’t make back the money invested in them. Most movies lose money. So the one-in-ten that actually makes money has to pay for all the rest.

If the studio only charged 3% interest, it would work out great for Brad Pitiful and his profit sharing story. In a world where the movie made 40 million in revenue and had only 10 million in interest costs with 30 million of profit, Brad would have gotten 15% of 30 million, or 4.5 million in bonus dough.

But the books aren’t being cooked here. They are just being zapped...by interest costs.