A long time ago, in a galaxy far, far away, people used to buy lots of DVDs. The big studios could often rely on making as much money from selling the discs as they could from theatre-going audiences.

The heyday of making strong revenues from DVD sales was only about 15 years ago. Spending on film production soared at the time, as studios became accustomed to the higher revenues, but it has not come down since even though DVD revenues have fallen.

A further squeeze on budgets brought about by the onset of the financial crisis was enough to persuade filmmakers to seek new ways to spread the sizeable risk of film production.

Most big studios, with one important exception, now rely on external investors to co-finance big films. As much as possible, they rely on incentives or tax breaks to cut filming costs. After initial release, international markets, especially China, can also serve to provide a large boost. Other revenue sources are becoming increasingly important, including view-on-demand streaming services. Meanwhile, video games and merchandising continue to provide additional income.

“Film is actually doing very well . . . [but] digital distribution continues to be the grand disrupter,” says Kevin Klowden, managing director of the California Center at the Milken Institute, a think-tank that studies economics in the state. “It changes the economics of how Hollywood makes its money after release. A lot of these companies are in a situation where, as they can’t depend on the back end in videos, DVDs or even digital to prop up their numbers, they have either gone to co-financing or international financing deals.”

A popular way to co-finance movies has been so-called “slate financing”, says Mr Klowden. This involves investors, often hedge funds or wealthy people, putting money into a “slate” of several films that a studio will produce over the next few years. Slate financing mitigates risk and allows the conglomerates, which now control most of the big studios, to spend money on other activities.

CHART: Top 10 box office (Worldwide gross, 2015)

There are pitfalls. If the slate includes a couple of big flops, investors can be left high and dry.

The main exception to the co-financing trend has been Disney (which now owns Lucasfilm and its Star Wars franchise), which has experience in exploiting its intellectual property across a range of media, from merchandising to theme parks.

“One reason Disney may not elect to use slate co-financings is that film entertainment is not the most significant and vital part of their asset base,” says Amir Malin, managing principal of Qualia Capital, a private equity firm that invests in the media sector.

In recent years, the Asian market has become much more important for big films made in the US and Europe. This may have nudged Hollywood towards making more big-budget action films since explosions translate well, while snappy dialogue and culturally specific satire do not.

“Two decades ago, most industry sources would have expected a split of 60:40 between domestic and international box-office sales. Today, those ratios have flipped with some films . . . doing two or three times domestic performance [abroad],” says Mr Malin.

He says one driver of international growth has been a rising middle class in places such as China, Russia, Brazil and the Asia-Pacific region. But he adds: “Obviously we’ve seen explosive growth in China and it has become the second-largest film market in the world. That being said, the ability to generate profits from China is basically limited to the theatrical performance of a film given widespread piracy issues.”

Studios with existing film libraries are also allowing investment in their intellectual property. Investors can gain a share of revenues earned when stock is licensed for use by streaming services or television channels.

Analysts say that effective finance and distribution models exist for big, so-called “tent-pole” blockbusters that provide core revenue streams. Small independent films, meanwhile, can be paid for by a single source and recoup investment with a small release and ancillary market sales. It is the films in the $50m-$100m range that face the greatest difficulties.

One solution has been to sell international rights in advance, using that money to finance the film in the first place. Like everyone else, midsize films have increasingly sought out regions of the world which offer financial incentives, such as tax breaks. This helps to explain why Atlanta in the US and London in the UK have become such important filming locations, says Adrian McDonald, research analyst at FilmLA, which processes public permits for filming in Los Angeles.

“Very few of the recent tent-pole movies are made in LA [Los Angeles]. When you can get that much money back [for filming in an alternative location], why wouldn’t you take it?” says Mr McDonald. “They’re often referred to as tax incentives but in reality they are not,” “It’s just financing.”

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