Marshall School of Business
University of Southern California

FBE 552
Economics and Finance of the Entertainment Industries

Spring, 2000

Prof. Mark Weinstein

Cartoon ©1997 The New Yorker

In this course we will cover the basic economic and financial analyses that are needed in the entertainment industries. By the end of the course, you should have accomplished two things. First, you should have some understanding of the basic economic theory governing exploitation of intellectual property in the main entertainment media (motion pictures and television) and some exposure to the related entertainment media of recorded music, live theatre and video games. Second, you should have some appreciation of the financial analysis that is common in the entertainment industries.

The only prerequisites for this course are the finance, accounting and economics courses that are included in the first year of the MBA curriculum. If you have not had these courses, please see me immediately.

The textbook for this course is Entertainment Industry Economics by Harold Vogel. Vogel is a financial analyst with a brokerage firm and this book provides the only outline of the entertainment industries that is specifically designed for an outside financial analyst. Along the way he provides a lot of useful overview of the size, scope and cash flows in the industry.

There are also a number of pdf files on the website for this course, which you can reach by going through my website at http://marshallinside.usc.edu/mweinstein/teaching.html. This document contains hyperlinks to the readings.

I have divided the readings into three categories
    Required readings are necessary for your understanding of the course
    Recommended readings are designed to help you understand the required readings, or to further explore some issue
    Supplemental readings are not required, but are either interesting applications of the concepts, or things I  thought you might find interesting in general.

You may want to check out Daily Variety and/or the Hollywood Reporter on a regular basis.

The class will be a mix of cases and lecture/discussion. I have arranged for a few guest speakers from the industry to discuss specific topics.

Your grade will be determined by a weighted average of the following: class participation (40%), your grade on the final exam (60%). As an alternative to taking the final exam, I offer the option of writing a term paper. The term paper should be an analysis of a major issue facing the entertainment industries. The term paper MUST include significant empirical analysis and must represent original research. While the topic is open, it must have my approval. I suggest that you start thinking about topics immediately. The paper will be graded on all aspects including organization and grammar.

In evaluating class participation I will be considering the contributions that you have made to furthering the discussion of the topic at hand. Mere opening your mouth is not good class participation. I am looking for comments that are thoughtful and lead the discussion forward, not astray.

My office is HOH702G (x06499). I try to maintain a fairly liberal policy regarding office hours. My formal hours are Th 4:00 – 5:00, but I try to be available at any time. I can also be reached by First-Class, or regular e-mail (mweinstein@marshall.usc.edu) I am an avid user of e-mail and try to respond quickly. Often e-mail is the easiest way to get to me. I have established a conference for this course. I would prefer that you post any question dealing with course material to the conference so that both the question and my answer are available to all. I encourage discussion and posting of messages on the class conference. In general, I will try to refrain from answering questions until the class has had time to mull it over and students have had time to answer the posted questions.

Also, this syllabus, is, of necessity, incomplete. At this time I have not been able to finalize all the guest speakers.

Introduction to the course

The Movie Title Trivia contest:    In his decision in U.S. v Syufy, Judge Alex Kozinski included the names of over 200 movies as part of the text. By the end of the semester the person who has found the most titles will get an extra  point on the final exam.

Some of what makes Entertainment interesting is that so much of the value creation is tied to ownership and development of intellectual property. See this article on the difficulty in determining who owns the movie rights to Spider Man for an (albeit extreme) example.

The stuff that dreams are made of.

Discussion: The Macro View

Readings:
    Required:
        Vogel Ch.1
        1998 MPAA Economic Review
    Recommended:
        Vincent Canby, Somebody Must Put the Lid on Budgets, New York Times (November 27, 1977)

Examine the data on consumer expenditures in Appendix C of Vogel. What, if anything, does this data tell you about the relation between income and leisure expenditures? Do all classes of leisure expenditures behave the same way as income changes? What would you expect to happen to the relative expenditures on live theatre vs. movies as income changes? Does the data support this hypothesis?

Examine the MPAA Economic Review. What inferences can you draw from this data? You might look at the relation between movie attendance and the number of screens, and the relation between box-office revenue and the cost of production, distribution and marketing. What has happened to the real (inflation adjusted) cost of making, distributing and attending a movie?

Nobody goes there anymore, it’s too crowded

We observe that the entertainment industries are very hit driven. Only a very small number of films, records or TV shows are responsible for the vast majority of profits in the industry. Why is that so? Is there an economic explanation for this?

Discussion: Economic Foundations I:     Skewed!

Readings:
    Required:
        Note on Interdependent Utilities
        DeVany and Lee, Information Cascades in Multi-Agent Model Unpublished working paper, Department of Economics, University of California, Irvine [You are only responsible for the introductory sections, literature review and the conlcuding section, that is, the non-technical stuff]
    Recommended:
        DeVany and Walls, Bose-Einstein Dynamics and Adaptive Contracting in the Motion Picture Industry, 106 Economic   Journal 1493 (November, 1996).
        DeVany Hollywood is an Uncertain Place: Kim Basinger’s Ordeal and Complexity in the Movies. Unpublished working paper, Department of Economics, University of California, Irvine (1997).
        For a non-technical introduction to the economics of fads and cascades you may find Bikhchandani, Welch and Hirshleifer, Learning from the Behavior of Others: Conformity, Fads and Informational Cascades useful.

I’m still big, the pictures got small

Not only is it true that success is concentrated in a small number of movies or TV shows, but it appears that only a small number of performers are very successful. What does economics have to say about the phenomenon of super-stardom.

Discussion: Economic Foundations II:    Why did G-d Make Superstars?

Readings:
    Rosen, Sherwin, The Economics of Superstars, 71 American Economic Review 845 (December, 1981).
    In this Reply to a comment on his paper Rosen clarifies a point, and identifies an important tradeoff associated with new media at the end.
    Notes on Rosen, The Economics of Superstars

Discussion: Economic Foundations III:    What is inside the firm and what is outside the firm and the role of vertical integration

Readings:
    Required:
        Rich, Frank Tina and Disney Elope, New York Times (July 11, 1998)
        Klein, Crawford and Alchian, Vertical Integration, Appropriable Rents, and the Competitive Contracting Process, 21 Journal of Law and Economics 297 (1978)
    Supplemental:
        Williamson, Oliver, The Vertical Integration of Production: Market Failure Considerations, 61 American Economic Review 112 (1971)
         McKean, Discussion of Williamson
         Here is an L.A. Times story on Murdoch's purchase of Manchester United.
        You should look at this in the light of what you are learning about the economics of vertical integration. Thursday Night Massacre, New York Times, Sept. 20, 1998

The Motion Picture Studio

The American cinema is a classical art,
but why not then admire in it what is most admirable,
i.e., not only the talent of this or that filmmaker,
but the genius of the system.

André Bazin, 1957

Discussion: The Motion Pictures Studio: History, Evolution and Economics

Readings:
    Required:
        Vogel Ch. 2, 3
        Robins, James, Organization as Strategy: Restructuring Production in the Film Industry, 14 Strategic Management Journal 103 (1993)
    Recommended:
        McDonald, Gerald, Origin of the Star System, 4 Films in Review 449 (November, 1953).
    Supplemental: Paul, Alan and Archie Kliengartner, Flexible Production and the Transformation of Industrial Relations in the Motion Picture and Television Industry, 47 Industrial and Labor Relations Review 663 (July, 1994).
    Miller, Danny and Jamal Shamsie, The Resource-Based View of the Firm in Two Environments: The Hollywood Film Studios from 1936 to 1965, 39 Acadamy of Management Journal 519 (1996)
    Gunther, Mark, The Rules According to Rupert, Fortune (Oct. 26, 1998)

Discussion: The Motion Pictures Studio: History, Evolution and Economics (continued)

The State of the Industry

Guest Speaker:

Jeff Logsdon
Executive Vice-President
Entertainment and Gaming Analyst
The Seidler Companies

The Economics of Sharing Contracts in Hollywood

Discussion: Profit Sharing Contracts

Readings:
    Required:
        Net Profits Rider from Fox
        Deal Structure Definitions
        Weinstein, Mark, Profit Sharing Contracts in Hollywood: Evolution and Analysis, 27 Journal of Legal Studies 67 (January, 1998)
    Recommended:
        Chisholm, Darlene, Asset Specificity and Long-Term Contracts: the Case of the Motion Picture Industry, 19 Eastern Economic Journal 143 (Spring, 1993)
        Buchwald v. Paramount (Second Phase), Decision by Schneider, J., Calif. Superior Ct., Dec. 21, 1990
        Batfilm v Warner Brothers, Decision by Yaffe, J., Calif. Superior Ct., March 14, 1994
    Supplemental:
        Connors, Tim, Beleaguered Accounting: Should the Film Industry Abandon It’s Net Profits Formula, 70 Southern California Law Review 841 (March, 1997). [Skip Section III (though you may find section III.A useful)]
        Estate of Jim Garrison v. Warner Bros., et. al., First Amended Complaint (Excerpts), United States District Court, Central District of California.

All of the readings deal with the contracts between the studio and talent. Another place where sharing contracts are used is between the distributor and the exhibitor. In this working paper Hanssen shows that priot to the advent of sound theatre owners paid a flat rental for a movie, but that after sound came in the contract form changed to one with revenue sharing. He shows how the change in the nature of the movie and the movie show led to the change in contract form. This is a fun paper, non-technical with a good story to tell.
Hanssen, F. Andrew, The Effect of a Technology Schock on Contract Form: Revenue-Sharing in Movie Exhibition and the Coming of Sound, Unpublished Working Paper, Montana State University (1999).

Sequencing Exploitation

Discussion: Windows of Distribution

Readings:
    Required:
        Vogel, Ch. 2.4, 3.4
    Supplemental:
    Frank, Björn, Optimal Timing of Movie Releases in Ancillary Markets: The Case of Video Releases, 18 Journal of Cultural Economics   125 (1994)
    You would think that by now everyone would understand the role of follow on markets, but that is not always the case. See this article.

International Competition and the Sources of Comparative Advantage

Case: The MPAA and GATT

Questions:

1. Who was right in the debate over audiovisual services? Why did the GATT negotiations on audiovisual matters become so heated?
2. Why is the United Sates the world leader in the filmed entertainment industries?
3. Evaluate the strategy the MPAA used during the GATT negotiations. What would you have done similarly? What would you have done differently?
4. What approach should the MPAA take with respect to the EU in the aftermath of the GATT signing?

Here is a background reading on the "cultural dominance" of the US entertainment industries from the Economist.

From the New York Times

International Competition in Animation

Gueast Speaker:

Mr. Alain DuMort
European Union Fellow and Associate Professor
School of International Relations
USC

Communication From the Commission of the Council, The European Parliament, The Economic and Social Committee and the Committee of the Regions: Principles and Guidlines for the Community's Audiovisual Policy in the Digital Age

The Economics of Exhibition

Case: Coming Soon, A Theatre Near You

Questions

1. Are the trading relationships between the studios and the exhibitors likely to be stable?
2. In the relationship between the studio and the exhibitor, when are are the prices set? Where does value creation occur? What leads to value creation?
3. Who has been capturing the value in the typical deal between the studio and the exhibitor?
4. How does the move from single screen to multiplex theatres affect the relations between studios and exhibitors?

Readings:

    Recommended:
        Constance Hays, Managing a Megaplex Takes Mega-Effort, New York Times (December 29, 1997)
        Vogel Ch.3.4
        United States v Syufy
        Here is a good analysis of Block Booking by Andrew Hanssen

    Supplemental:

This was moved to 4/27

New Technololgy in Exhibition

Guest Speaker:

Mr. Douglas Olin
Digital Cinema Associates

Readings:
    Two articles on Digital Projection of Movies. One from the New York Times, the other from the Economist.

Predicting Movie Success

Discussion: Predicting Movie Success

Readings:

An Independent Production from Acquisition to Home Video

Guest Speaker:

Mr. Thomas J. Taylor

Background Reading:
    Frumes, Howard, Surviving Titanic: Independent Production in an Increasingly Centralized Film Industry, 19 Loyola of Los Angeles Entertainment Law Journal 523 (1999)

Applications of Option Pricing Prinicples to Movies or
It seems we’ve stood and talked like this before

Case: Arundel Partners: The Sequel Project

Questions

1. Why do the principals of Arundel Partners think they can make money buying movie sequel rights? Do you expect any major film studios to be interested in the sort of arrangement described in the case? What are the substantive differences, if any, between buying a portfolio of sequel rights all at once and negotiating film-by-film to buy them?
2. Estimate the per-film value of a portfolio of sequel rights such as Arundel proposes to buy. [There are several ways to approach this problem, all of which require some part of the dataset presented in Exhibit 6–9. You may find it helpful to study the Appendix, which explains how these figures were prepared.]
3. What are the primary advantages and disadvantages of different possible ways to estimate the value of the sequel rights? What further assistance or data would you require to refine your estimates of the rights’ value?
4. What problems or disagreements would you expect Arundel and a major studio to encounter in the course of a relationship like that described in the case? What contractual terms and provisions should Arundel insist on? What sort of due diligence should Arundel undertake?

March 9, 2000

What is a TV Network?

Discussion: What is a TV Network?

Readings:

    Required:
                Vogel, Ch 6
                Carter, Bill, Let's Make a Deal: The New Fall Schedule, New York Times (May 25, 1998)

Case: Fox Broadcasting Company

Questions:

1. Why were the three television networks historically able to sustain high profits?
2. How has the structure of the broadcast television industry changed in the late 1970’s and early 1980s?
3. How to these structural changes affect the barriers to entry into network broadcasting?
4. Should Fox Broadcasting Company (FBC) be attempting to become the fourth television network?

Readings:

The Market For Programs

In order to understand the market for television programs, we examine the economic theory of program selection and also look at role of regulation in this market. The most important regulations, now repealed, were the "financial interest and syndication" rules that were in efect from 1970 to 1993. Looking at the effect of these rules, and their repeal, provides evidence about the structure of the market. The first reading is Judge Richard Posner's decision that lead to the repeal of the fyn-syn rules. Always cogent, Posner (he has recently been appointed to mediate the Microsoft case) provides a non-technical analysis of the rules.

Readings:
    Required:
        Schurz Communications v. Federal Communications Commission (982 F.2d 1043)

A Slight Detour Back to Movies:
Financial Analysis and "Greenlighting" a Movie

Guest Speaker:

Mr. John Amusson
Senior Vice-President, Finance
Twentieth-Century Fox

The Regulatory Environment and Cable

Case: Paragould City Cable

Questions

1. Who are the winners and losers from public/private competition in Paragould’s cable TV market? What is the dollar value of gains or losses form competition to the relevant individuals or institutions?
2. Is the provision of cable television service in Paragould, Arkansas, a natural monopoly? What approaches other than direct municipal competition could the city of Paragould have employed to improve cable television service in the city?
3. What is your evaluation of City Cable’s performance through August, 1993? What is City Cable’s breakeven number of subscribers at current prices? What is the company’s breakeven price at its current subscriber level?
4. What changes, if any, would you recommend with respect to City Cable’s current strategy? What changes would you recommend to PCI regarding its current strategy?
5. Under what circumstances is competition between publicly and privately owned firms appropriate?

March 28, 2000

There’s no crying in baseball: The Economics of Professional Sports Teams and Leagues

"First of all, I'd like to talk to you about starting salaries in the major leagues."

"You are going to either play on a baseball team or get a salary cap."

The Summer Game (and Others)

Case: The Baseball Strike

Questions

1. Up to the time of the strike, was value creation in Major League Baseball increasing or decreasing?
2. Who has been capturing this value? Who has been creating this value?
3. Why did free agency change things so much?
4. Do any of the options on the table for resolving the dispute look promising?

Reading:

Vogel, Ch. 11

If we are going to apply economics to the action to team owners, we need to know if they are actually trying to maximize profits.
D. G. Ferguson, et. al. The Pricing of Sports Events: Do Teams Maximize Profit, 39 Journal of Industrial Economics 297 (1991)

Supplemental Readings:

Some other stuff that you may like:

You may find Selig v. U.S., 565 F. Supp. 524 interesting. When a new buyer purchases a professional sports team, one of the assets that is acquired is the set of then existing player contracts. In 1959 the well known baseball entrepreneur, Bill Veeck, got an IRS ruling that allowed him to depreciate the players' contracts with the Chicago White Sox when he purchased the team (the team won the American League championship that year, its first since 1919, and the Sox haven't won since). The Veeck ruling appears to have increased turnover of major league teams as the contracts are depreciated over five years and new contracts cannot be depreciated. However, upon sale of the club a new owner can depreciate the contracts. When the current commissioner of baseball, Bud Selig, purchased the Seattle Pilots and moved them Milwaukee as the Brewers, he allocated over 95% of the purchase price to the contracts, so he could depreciate them. The IRS disallowed and Selig sued. This is the district court decision that presents an analysis of the pre-free agency market for ballplayers. Selig won.

You may also note that there is a tendency among judges (usually male) to wax poetic when they get to write about baseball. Parts of these decisions can make for entertaining reading. The first example of this tendency is Judge Bauer's decision the appeal of the Selig case. He affirms the lower court ruling. Also, there is Justice Blackmun’s opinon (and related opinions) in Flood v. Kuhn. This was the last major case to uphold the reserve clause. What is Justice White is saying in his concurring opinion?

In December, 1975, an arbitrator declared that Andy Messermith and Dave McNally were free agents because they had played the 1975 season without signing their contracts. The arbitration provision had been added to the agreement between the owners and the players in 1973. The owners fired the arbitrator, Perter Seitz, and appealed his decision to the courts. Seitz’ ruling was upheld. I have posted the District and Circuit Court decisions upholding Seitz’ ruling. These are more arcane, but may be of interest.

Even more stuff you may like that is also optional:

Daly, George, The Baseball Player’s Labor Market Revisited, in Summers, P. ed., Diamonds are Forever (Washington, The Brookings Institution), 1992.

Quirk, James and Rodney Fort, "Competitive Balance in Sports Leagues," Chapter 7 from Paydirt, The Economics of Professional Team Sports, (Princeton, Princeton University Press) 1992.

Quirk, James and Rodney Fort, "Why Do Pro Athletes Make So Much Money," Chapter 6 from Paydirt, The Economics of Professional Team Sports, (Princeton, Princeton University Press) 1992.

 

Here are two articles on the role of sports at News Corporation. Murdoch's purchase of the Dodger's is discussed here, and this article shows that the combination of sports and media is not just an American pheonomenon.

The New York Times Magazine of October 18, 1998 was devoted to the business of sports. Here are a few items from that issue.
    This is a rather playful diagram showing how media and sports are combining. Best viewed at school as it is a big, color, file.
    Here is an article showing how the Florida Marlins understate their true profitability
    And here is another, more comprehensive, piece on Murdoch and sports that examines some of the ways the entertainment conglomerate may affect the game.

    Here is article on the selling of the NBA even without any games

Professional Sports (Continued)

Reading:

In this reading Fort and Quirk provide an economic analysis of the ways in which sports leagues try to maintain competitive balance:
Rodney Fort and Jame Quirk, Cross-subsidization, Incentives, and Outcomes in Professional Team Sports Leagues 33 Journal of Economic Literature 1265 (1995).

April 6, 2000

Introduction from the Studio Perspective

Guest Speaker:

Mr. Richard W. Cook
Chairman
Walt Disney Pictures Group

April 11, 2000

April 13, 2000

Licensing

Case: Jurassic Park

Questions

1. How is value created and extracted in the motion picture industry?
2. How should licensees be selected?
3. What are the benefits and risks of merchandise licensing for motion pictures?
4. What special challenges are involved in developing the merchandise licensing program for Jurassic Park?

April 18, 2000

More on the Entertainment Firm

Case: Viacom, Inc.

Questions

1. Compare Viacom’s pre-1993 operating strategy with its strategy after the Paramount acquisition.
2. Compare Viacom’s operating strategy with News Corp.’s?
3. How do the differences in operating strategies relate do differences in views on the ultimate source of value creation in these industries?
4. Which decision, the supply contract or the equity participation is more consistent with Viacom’s view of the world? Why? Which would you recommend?

Supplemental Reading:

McElvogue, Louise, US Cable Firms Find Tough Crowd Abroad, Los Angeles Times (August 27, 1998)
Economist Magazine Survey of Technology and Entertainment (November, 1998)
Carter, Bill, Shrinking Network TV Audiences Set Off Alarm and Reassessment, New York Times (November 22, 1998)

April 20, 2000

No Class Today
see "Prince of Egypt"

April 27, 2000

Readings:

On the Qualcomm website (http://www.qualcomm.com/ProdTech/digitalcinema/papers.html) is a paper (in pdf format) entitled:     Making Digital Cinema Actually Happen by Steve Morley (presented at the SMPTE 140th Technical Conference, Pasadena, CA, October 31, 1998).

    Two articles on Digital Projection of Movies. One from the New York Times, the other from the Economist.