Netflix jumps into the movie production business

Many people in the movie and television businesses have believed that given Netflix's success with original television series, it was only a matter of time before the company would begin producing movies. Those beliefs have been confirmed in a big way: Last week, Netflix announced that it has partnered with The Weinstein Company and IMAX to produce a sequel to "Crouching Tiger, Hidden Dragon" called "Crouching Tiger, Hidden Dragon: The Green Legend," and today, Netflix announced a four-picture production deal with Adam Sandler and his Happy Madison production company.

The terms of the deals aren't public knowledge, but some of the plans have been revealed: In the "Green Legend" deal, IMAX was brought in to distribute the film to IMAX theaters. IMAX develops the cameras, projectors, screens and processing software for its various formats, but its theaters are actually owned and operated by other parties, and a number of those parties in the U.S. are very unhappy. The four largest theater circuits in the U.S., Regal, AMC, Carmike and Cinemark, have said that they won't show the sequel. Cineplex in Canada and Cineworld in Europe have also refused to show it. That doesn't completely eliminate IMAX as a viable outlet for the movie, because there are many IMAX theaters operated by museums and public institutions, and smaller theater chains with IMAX theaters may decide to show it.

It's not clear whether Netflix changed its strategy overnight or whether it had already expected the theater chains to react the way they did, but in today's announcement, Netflix said that none of the four movies to be produced by Adam Sandler will be shown in theaters. In addition, they also made clear that none of the movies that Adam Sandler or Happy Madison are already committed to for other producers or distributors are included in the four films.

No one should be surprised that big theater chains won't show Netflix's films--they've pushed back against major studio day-and-date Video-on-Demand (VOD) tests (the movie is released in theaters and on VOD on the same day,) starting with Universal's "Tower Heist" in 2011. By and large, the big studios have backed off of day-and-date VOD, but they're aggressively testing shorter windows between some movies' theatrical release and their availability on VOD. Smaller independent studios such as Magnolia Pictures have adopted day-and-date VOD releases. 2929, parent company of Magnolia, also owns Landmark Theaters, which has 50 theaters in 21 markets, so Magnolia is guaranteed of theatrical distribution in many major cities, no matter what other theater chains decide.

It's likely that Netflix is structuring its movie production deals with the expectation of no domestic theatrical revenues. Whatever theatrical distribution Netflix gets will be promotional, not a significant revenue generator. Over time, if Netflix's movies prove very popular, the big theater chains may be forced to start bidding for the right to show them in their markets. However, for now, the safest move for Netflix is to budget movie production in line with VOD revenues.

Earlier today, The Verge reported on Adam Sandler's deal with Netflix, and wrote:

Under the deal, Sandler removes the burden of risk. Netflix will solely fund the films, taking full responsibility for providing investment — and securing additional investment — off Sandler's Happy Madison Productions. Though Netflix will be the sole financier, the films will still have their $40 million to $80 million budgets. Sandler's payments are a large chunk of his films' budgets. He reportedly receives $15 million and over per film as an actor, and can make an additional $5 million as the producer, which explains how Grown Ups 2, a comedy with a handful of special effects, reportedly cost $80 million. On top of all that cash, it's likely Sandler and his production company will make an additional, undisclosed lump sum of money simply by signing the deal. Netflix decline to provide comment to The New York Times on the specifics of the agreement.

It's inconceivable to me that they would agree to pay production costs anywhere near $40 to $80 million or $15 million per picture for Sandler's acting, especially since Sandler's last several movies have bombed in the U.S. Netflix probably has a "back-end" deal with Sandler that pays him additional compensation if the movies reach or exceed performance targets, such as the number or percentage of subscribers who watch them. As the Verge article points out, Sandler laces his films with product placements, which can defray some production costs, or put money into his pocket. That might be enough to enable Sandler to, say, produce a film for $25 million, get $10 million in product placement funds, deliver the movie to Netflix for $20 million and put $5 million before tax into his pocket.

Netflix may be the first VOD company that will underwrite major motion pictures for its own distribution, but it almost certainly won't be the last. I expect Amazon to follow suit, and possibly Redbox. (Update, October 4, 2014: TechCrunch reported today that Redbox will shut down its streaming service on Tuesday, October 7.  That makes it much less likely that the company will get into original production.) SoftBank, the owner of Sprint in the U.S, SoftBank Mobile in Japan and the single largest shareholder of China's Alibaba, just invested $250 million for 10% of Legendary Entertainment, with options to invest a total of $750 million more between now and the end of 2018. Legendary, whose movies are co-financed, marketed and distributed by Universal, could produce movies for SoftBank and Alibaba should either company decide to distribute its own original titles.

Part 1: Birth, Death and Transformation

We’re in the midst of a massive shift in media consumption patterns. People consume more news than they ever did, but they don’t read newspapers anymore. Magazines, even on tablets, are slowly dying. And, as for books, The New Yorker published an article titled “Twilight of the Books”…on December 24, 2007, before eBooks were even a significant part of the business. Statistics in the article show that the market for books has been declining for at least 30 years. U.S. movie theater ticket sales peaked in the 1950s; the only things that have kept the industry going have been home video sales and higher ticket prices. But, home video sales are also dropping—they’re being replaced by rentals from Redbox, and online streaming from Netflix, Amazon and others.

Let’s be clear: Movie attendance has been declining for half a century, but no one seriously expects the movie business to disappear. The same is true for books; readership will continue to decline, but it’s hard to visualize a world without books, even if most of the remaining books are digital instead of paper. Nevertheless, the balance has shifted. Consumers want their media faster and cheaper. Readers want their news from the Internet, as it happens (if not sooner, leaked out via Twitter.) One can argue that attention spans have gotten shorter—look at the popularity of viral videos on YouTube—but videogames, both casual and complex, can engross players for hours or even days.

The transformation of media in the 21^st Century is being driven by three forces: The Internet, mobile devices and wireless broadband. The Internet provides a conduit for every kind of content. There’s no need to ever leave your house to purchase any kind of media, and it makes possible entirely new types and combinations of media that didn’t exist prior to the rise of the World Wide Web. Mobile devices and wireless broadband make that content available anywhere, anytime, and open the digital world to hundreds of millions of people who can’t afford personal computers or high-speed Internet connections.

Print vs. eBooks: Deck chairs on the Titanic?

Earlier today, I wrote about a panel on eBook collection development at this year's American Library Association annual conference. You can read the post, or the original article, for more information, but I found a couple of points very interesting (or scary, depending on your perspective):

• The King County Library System has increased its eBook budget by 60% in each of the last three years, but the library's overall budget has been flat. To get the money for more eBooks, the library has cut its reference subscription database budget in half.
• The Free Library of Philadelphia is trying to expand its eBook collection, even while the library's budget for materials was recently cut by 50%.

Libraries throughout the U.S. are lucky if their budgets have been flat; most have had big cuts to their budgets, even while demand for eBooks grows. To fulfill that demand, libraries are cannibalizing their budgets for print books and online content. Heavy book buyers are purchasing more eBooks, because they're less expensive than print, but moderate book buyers appear to simply be substituting eBooks for print equally, and light book buyers are only just starting to buy eBooks. It's highly doubtful that they'll do anything more than substitute eBooks for print.

So, where does that leave publishers? Book sales in general have been declining for years, and print sales are declining faster than eBook sales are growing. Luckily, the problem isn't as serious as the decline in home video sales for movie studios, or the decline in music sales at record companies. In addition, publishers are capturing most of the revenue shift from print to eBooks, while home video revenues are shifting to companies like Netflix and Redbox, and record companies are still fighting a high rate of piracy. However, that's putting the best possible spin on a very bad situation.

eBooks aren't going to save the book publishing industry. In fact, the only thing that can is a reversal in the industry's long-term secular decline trend, and there's precious little effort being put into that.

The radically reshaped media landscape

Today's media landscape is very different than it was even a few years ago. You might casually, or even professionally, follow one media business or another, but it's only when you look at all major media segments together that you understand just how radical the changes have been:

• DVRs have fundamentally changed the way that people watch television. Viewers are saving up entire seasons of shows and watching them all at one time, finding something better to watch on the DVR at 10 p.m. instead of watching network television, and skipping enough commercials that it's having a serious impact on the bottom lines of networks.
• Movie studios' home video revenues are in serious decline. Consumers are renting from Redbox and Netflix instead of buying DVDs, Blu-Ray is growing much too slowly to make much of a difference, and streaming video revenues haven't replaced, and probably will never fully replace, DVD revenues.
• As of July 3rd, Netflix became more popular than any U.S. cable network, according to BTIG analyst Richard Greenfield. Greenfield estimates that Netflix now has around 24 million subscribers, and the company itself said that its users watched more than one billion hours of video in June. That works out to around 80 minutes of viewing per day. In Netflix households, the service even beats ABC and CBS. Every minute spent watching Netflix is a minute that a broadcast or cable network isn't showing that person a commercial.
• Internet videos are finally making serious inroads into broadcast and cable viewership. It used to be that television networks simply used the Internet as a "farm system" to identify rising talent, but there are now too many people producing interesting Internet shows and not enough network slots to put them into. The Internet, unlike broadcast and cable, has an unlimited number of time slots and no requirement to get carriage from cable or satellite companies.
• Newspapers have cut all the editorial and production staff they can while still staying in business. They're now cutting back on deliveries and days that they print their papers. The only remaining step for many of them is to drop their print versions altogether and try to survive in digital form.
• Self-publishing has moved from the last resort for desperate authors to the fastest-growing segment of the U.S. book industry. Authors who could have gotten publishing contracts are choosing instead to self-publish, and are making more money as a result. Authors who were widely rejected by agents and publishers are turning to self-publishing and, in some cases, finding big audiences. (As with Internet video, major publishers see self-publishing as a "farm system," but it's only a matter of time before the farm teams overwhelm the big leagues.)
• Internet music services such as Spotify and Pandora are having a major impact on both the recording and radio businesses. Record companies are becoming more dependent on subscription music services for revenues; radio stations are losing part of their audiences to paid, commercial-free services. Car companies are adding Internet music services to their infotainment systems, making them as easy to access and convenient as broadcast and satellite radio.

There isn't one major media business--television, cable, movies, newspapers, books, music or radio--that isn't undergoing a dramatic upheaval. All of the changes favor new entrants. Rather than fighting back with innovation, most major media companies have resorted to litigation, lobbying, restraint of trade and refusal to deal in order to try to hold back competitors, or to support their customers that are trying to hold back competitors. In the short run, these tactics often succeed, but in the long run, they'll undoubtedly fail. You can't hold back the ocean forever.

Consumption of online movies passes physical movies for the first time

If physical DVDs and Blu-Ray discs aren't dead, they're certainly in the process of shuffling off this mortal coil. According to Broadband TV News, IHS Screen Digest forecasts that legal, paid consumption of movies online  in the U.S. will reach 3.4 billion views in 2012 from 1.4 billion last year, while views from physical media (Blu-Ray and DVD) will decline to 2.4 billion from 2.6 billion last year. Online views will grow 135% year-over-year.

IHS forecasts that 2012 will be the crossover point, when online viewing of movies (including video-on-demand) will first exceed rental and purchase of physical media for watching movies. 2.4 billion views on physical media is nothing to sneeze at, of course, and it'll be years before DVDs and Blu-Ray discs become insignificant. Nevertheless, the handwriting is clearly on the wall: Consumers are getting comfortable with renting and watching movies online.

There are three reasons why online viewing won't grow even faster:

• Redbox's $1.20/day rental fee and huge installed base of kiosks makes its service both cheap and convenient for consumers, 
• Renting and buying physical media enables consumers to use the millions of DVD and Blu-Ray players they already own, and
• Movie studios are still holding back most of their recent releases from Netflix and other services.

New devices, such as Roku's "streaming stick", will make adding streaming Internet video to millions of HDTVs even easier than it is today. It's entirely likely that physical media will be obsolete before the end of this decade, especially if movie studios make more of their releases available for early streaming.

Attention Joe Clayton: Can you call off your comment spammers?

Anyone who's followed the consumer electronics industry knows Joe Clayton. He was a vice-president at RCA in Indianapolis for years, helped to set up and then ran DirecTV, moved into the telecom industry to run Frontier and Global Crossing, came back into media as the head of XM Satellite Radio, and was appointed the president and CEO of DISH Network last June. Joe's very well respected in the industry, but something that DISH is doing is causing me to lose respect for the company, and he can stop it with a single email.

Whenever I post a story about any player in the home video business, such as Netflix, Redbox or Blockbuster, I get comments on the post that are very similar in tone and style, although they're always posted by different people, or at least, people using different identities. My most recent post, on Redbox's latest announcements, got this reply, from someone named "gman":

I agree that “they” have a lot to do in the meantime, but they seem confident that it can be accomplished in the next 6-10 months. Critics aren’t as confident they will be as successful compared to Netflix who has been butting heads with people like HBO and Starz. I do not intend to cut the cord anytime soon, mostly because I get my programming from my employer, Dish, but now that I get the Blockbuster @Home for $10 a month with my TV service AND it includes over 100,000 titles streaming and for disc rental I know that I have something special. The combining of these services is what pleases the distribution companies and I benefit from current TV programs, so win-win.

Notice how the comment starts as a legitimate input but turns into an ad for Blockbuster @Home. Notice also the mention of DISH as the commenter's employer. All of the suspect comments say that the commenter works for DISH, which as you may know, owns Blockbuster. However, the comments never directly acknowledge that DISH and Blockbuster are the same company. Given the similar wording and contents of the comments, there's no way that they're not being written either by DISH or by contractors working for DISH.

If DISH wants to buy advertising space on this blog, I'd be happy to sell it to them, but they'd rather get it for free. I review every comment before it's posted, and I've caught and deleted all of the promotional DISH comments before they've gone live. I'll continue to do so. As far as I'm concerned, it's cheap and sleazy, and puts DISH at the same level as spammers selling fake Viagra. None of DISH's competitors do the same thing, at least to my blog.

Update, February 12, 2012: Apparently, this post really pissed off the DISH spammers who I called out. They didn't have the courage to actually respond to my charges, but they rated the post "one star", hoping that it would deflect potential readers. So, I touched a nerve. I expect to touch a few more in the coming weeks.

Redbox partners with Verizon for video streaming, buys NCR's video rental kiosk business

Coinstar, the owner of the Redbox service that operates 29,000 video rental kiosks in retail locations in the U.S. and Canada, made two big announcements today:

• A joint venture with Verizon to enter the video streaming market, and
• A deal with NCR to acquire its video rental kiosk business

First, the joint venture with Verizon to enter the streaming video market. This deal has been rumored for months, but Verizon and Coinstar made it official today. Verizon will own 65% of the business, and Coinstar will own the remaining 35%. The service will compete directly with Netflix, and will launch in the U.S. in the second half of 2012. Coinstar and Verizon offered very few details about the service, but it will be available to all consumers with broadband Internet service, not just Verizon's subscribers.

Next, Coinstar will pay up to $100 million to acquire NCR's entertainment business, as well as pay NCR $25 million for goods and services over the next five years. NCR's entertainment business primarily consists of video rental kiosks operated under the Blockbuster Express brand; NCR licensed the brand name from Blockbuster. It's not clear whether Coinstar will convert the NCR kiosks to the Redbox brand, or will replace the NCR kiosks with its own devices.

How does all of this add up? Redbox was already the top video renter in the U.S. with 30 million customers, and the acquisition of NCR's business will both give the company even more locations and eliminate a competitor. The net result is that Redbox's video rental business, which is profitable and growing, will get even bigger and be better positioned to take business away from Netflix.

As for the streaming service, Coinstar's approach appears be the reverse of Netflix's, which is deemphasizing its video rental business in favor of streaming. Redbox appears to be betting that its kiosk rental business will remain strong while using Verizon's capital and infrastructure to stake a position in the streaming business. Verizon and Coinstar have released no details about their new service, so it's currently the equivalent of a "Watch This Space" sign. However, they have a lot of work to do before they launch, including:

• Signing licensing and distribution deals with content providers
• Building infrastructure to support video streaming across the U.S., not just on Verizon's own network
• Writing video clients for PCs, Macintoshes, iPhones, iPads, Android devices, Roku, Google TV, etc.

We'll know far more about how competitive the Verizon/Redbox service will be in the next six months.

Update, February 22, 2011: I just noticed that those pesky DISH spammers voted this post "one star" as well. If you're going to "p---" on the people who cover your industry because they refuse to give you free advertising, it most definitely will come back to bite you. At the very least, it opens questions about the financial condition of a company that has to rely on spammers instead of paying for advertising. But, I understand that DISH may be cash-poor after being forced by the courts to pay TiVo $500 million for stealing its technology.

Here's why the movie industry needs new revenues

AllThingsD reports that Rich Greenfield of BTIG has quantified the straits that the movie industry has found itself in. For more than a decade, DVD sales made up an ever-increasing majority of the industry's revenues. 2008's Great Recession flipped the DVD market from growth into decline, and the increasing popularity of Netflix and Redbox moved the home video market, which had transitioned from rental to purchase, back toward majority rental.

BTIG's numbers show how far the pendulum has swung. In the first half of 2010, U.S. sales of DVDs were just over $4 billion. Including Blu-Ray and electronic media, total home video sales were $4.998 billion. In the first half of this year, U.S. DVD sales were just over $3 billion--down almost 24% in one year. Blu-Ray sales, which were once seen as the great hope of the movie industry, were $810 million, up from $773 million a year earlier. The total for all physical media was less than the total for DVD alone last year. Electronic media sales increased year-over-year, but only from $260 million in 2010 to $270 million in 2011. Rental and Video-on-Demand revenues, on the other hand, increased from $3.782 billion in 2010 to $4.195 billion in 2011. The total rental market is now bigger than home video sales, and most of the rental revenues go to companies like Redbox and Netflix, not the movie studios.

This is why the movie studios are desperately trying every tactic they can think of to increase revenues, from $60 Video-on-Demand movies to UltraViolet digital copies of movies for online streaming. It's why Sony no longer wants to pay for 3D glasses, and why both movie studios and theaters are pushing 3D movies so hard. DVD sales were the lifeblood of the industry, financing ever more expensive movies and bigger promotional campaigns. With DVD revenues shrinking, studios are having to make difficult decisions, such as Paramount's recent decisions to consolidate its home video division with two other groups and to close its New York distribution office. At some point, studios are going to have to cut back movie budgets and possibly even cut the number of films they release each year.

The DVD "cash cow" is running out of milk, and there's nothing new on the horizon to replace it.

A $60 Video-on-Demand Movie? It's Comcastic!

Fierce Cable reports that Comcast, and its Universal Studios subsidiary, will test releasing a movie to Video-on-Demand (VOD) just three weeks after it opens in theaters. The movie is "Tower Heist", starring Ben Stiller and Eddie Murphy, which opens November 4th, and Comcast will run the test in Atlanta and Portland, OR. And the price? $59.95, for which you get to watch the movie once.

(Update--October 13, 2011: Home Media Magazine reports that Universal and Comcast have cancelled their plans to release "Tower Heist" on VOD after two theater chains, Cinemark and National Amusements, said that they wouldn't show the movie if the companies went through with their plans.)

DirecTV already has a program in place with multiple movie studios to show VOD movies 60 days after they open in theaters for $29.95. Comcast's argument is that large families can save money by watching the movie at home instead of buying movie tickets, food and drink. My counterargument is that a family that's looking to save money will wait a few more weeks and get the movie from Redbox for $1, and a family that has to see the movie as soon as it comes out vs. paying $60 to see it at home will go to the theater.

The movie studios are getting more and more desperate to replace the income they're losing from the decline in DVD revenues, and Comcast is trying to fight off Netflix and Amazon by offering movies and television shows sooner than the over-the-top video providers can. However, the value proposition for a $60 VOD movie that's already been in theaters for three weeks is extremely hard to make.

Dish Network buys Blockbuster for $320 Million

Reuters is reporting that Dish Network, the U.S. satellite video service provider, was the winning bidder for Blockbuster in U.S. Bankruptcy Court. Dish Network acquired Blockbuster for $320 million, of which $228 million in cash will be used to pay off the company's creditors (including movie studios) and bondholders. Blockbuster's total outstanding debt at the time of its bankruptcy was over $1 billion.

Dish Network gets a number of valuable assets as part of acquiring Blockbuster:

• Blockbuster has more than 1,700 stores, many of which Dish will likely close. The remainder, however, will likely start selling Dish's satellite service, streaming video service and hardware to consumers. Dish won't have to compete for shelf space with any other vendors. (Update, April 21, 2011: In a Bankruptcy Court filing earlier this week, Dish Network stated that it plans to keep only 572 of Blockbuster's stores open, although that number is subject to change.)
• Dish will become NCR's partner for its Blockbuster-brand video kiosks. To date, NCR/Blockbuster has done a poor job of competing with Redbox for locations, but Dish may give them access to new retail relationships.
• Blockbuster's set-top box and streaming video programs have largely failed to make any impact on Netflix, but Echostar, Dish's sister company, builds set-top boxes and owns Sling Media, the developer of the Slingbox. Echostar could build support for Blockbuster's streaming video service into its set-top boxes, and build new designs that could compete with Apple TV, Google TV, Roku, Boxee and others.
• Blockbuster has distribution deals with many of the major movie studios that gives it access to their DVDs and Blu-Ray titles 28 days before Redbox and Netflix. Dish could leverage those deals in a variety of ways, in a variety of channels.
• The Blockbuster trademark itself is still very valuable, even though it's been damaged by the company's ongoing bankruptcy. Dish has the option of using the Blockbuster trademark, its own trademarks, or a combination of the two, depending on the situation.

In short, for not a lot of money, Dish Network dramatically expanded its potential market opportunity and channels of distribution.

U.S. video rentals from kiosks now exceed rentals from retail stores

According to the NPD Group, in Q3 2010, rentals of DVDs and Blu-Ray discs from kiosks (primarily Redbox) exceeded those from retail stores (including Blockbuster) for the first time. Netflix and other subscription services accounted for 41% of all video rentals, while kiosks accounted for 31%, and in-store rentals accounted for 27%. Year-to-year, kiosk rentals increased 10%, subscription services increased 2%, and in-store rentals declined 13%.

Keep in mind that the numbers reported by NPD Group only cover rental of physical media; if streaming video and digital downloads were included in the figures, retail's share of video rentals would be even lower.

This news comes at the same time that Blockbuster received a two-week extension from the U.S. Bankruptcy Court to file a reorganization plan and hire a new CEO. The Dallas Morning News reports that Blockbuster is looking for as much as $250 million in additional financing in order to exit from bankruptcy. Bloomberg Television is reporting that some Blockbuster creditors are balking at putting more money into the company and are suggesting that the company liquidate.

In any event, Blockbuster's retail locations are an endangered species. For the company to survive, it has to increase its presence in the kiosk segment and build a viable online business.

Blockbuster enters Chapter 11 bankruptcy

As expected for months, Blockbuster has entered Chapter 11 bankruptcy in the U.S., and its equivalent in several other countries. Blockbuster says that its 3,000 U.S. stores will continue to operate as usual during the bankruptcy (but that's probably not true--see below). In addition, its video kiosk business is owned by NCR and isn't part of the bankruptcy.

Blockbuster has asked the Bankruptcy Court to allow it to give the movie studios and distributors that supply it with 80% of its revenues priority for repayment, so that they don't cut off the company's ongoing supply of content. Senior bondholders, including Carl Icahn, who bought approximately one-third of the company's bonds as of September 17th, will be compensated with common stock after the company is reorganized and will effectively own the company. Other creditors and shareholders, with the exception of the movie studios and distributors, will be wiped out by the bankruptcy.

Blockbuster will most likely use the bankruptcy to cancel the leases, layoff the employees and close many of its more poorly-performing stores. It will also use the bankruptcy to renegotiate leases for other locations, and possibly lower or eliminate some benefits and pensions. The company's hope is that by wiping out its debt and lowering its operating costs, it will be able to compete more effectively with Netflix and Redbox. However, given how far behind those two companies it is, it's hard to see how Blockbuster can catch up.

Are we at the end of the blockbuster film era?

NewTeeVee is reporting on a research report written by BTIG analyst Richard Greenfield, which states that the delays between the DVD release of feature films and their availability on cable VOD have collapsed from an average of 30 days in 2006 to five days in the first half of 2010. Now, most movies are being made available on VOD on the same day and date as DVD.

According to the article, Greenfield's belief is that movie studios have largely given up on protecting DVD revenues against VOD in favor of protecting the entire home video revenue stream against Netflix and Redbox. The typical price for a day-and-date VOD movie is $4.99 in SD and $5.99 in HD, and 70% of that revenue goes to the studio (versus 60% for conventional "windowed" VOD releases.) By comparison, Netflix's model is that they essentially pay the manufacturing cost for the DVD when they purchase it (often no more than a dollar or two (U.S.)) and then pay the studios a small amount every time a subscriber rents the title. Redbox purchases the DVDs at wholesale, and that's the only revenue the studios get; there's no revenue sharing beyond the initial purchase.

The problem is that the studios are making a lot less from VOD than from DVD sales, even though they don't have any manufacturing and shipping costs with VOD. Consider a DVD with a list price of $19.95; studios typically receive 50% of that, or $9.98. Manufacturing costs for most DVDs in the quantities that studios purchase them are $1 or less, so that leaves almost $9.00 for the studios for shipping and warehousing, advertising, royalties, etc.

Compare that with the $4.99 that cable operators charge for SD VOD films. Studios get 70% of that, or $3.50, and they have no manufacturing, shipping, or warehousing costs, but let's assume that shipping and warehousing adds $0.50 to their costs. That means that they get $3.50 from the VOD showing and $8.50 from the DVD sale. The $3.50 that they do get is much more than they get from Netflix or Redbox, but it's still $5.00 less than they get from DVDs.

The implications of this shift are much bigger than simply making less money per transaction. For more than ten years, DVD sales have been the profit engine driving the movie studios. Theatrical attendance has been dropping for years, and the only reason that the studios have been able to maintain their theatrical revenue stream has been increased ticket prices. The profits from sales of DVDs have enabled studios to dramatically increase their production and advertising budgets for feature films. These profits enabled studios to go ahead with films that cost $200 million or more to produce; their expectation was that with break-even performance in theaters, they could make a big profit from DVD sales.

Now, the DVD profit well is drying up, and Blu-Ray, which was once seen as the successor to DVD, isn't making up the difference and will likely never generate the level of revenues that DVDs once did. This explains the desperate push on the part of studios to adopt 3D. Theaters charge more for 3D tickets, and studios get as much as 80% of the ticket price for releases in their first few weeks in theaters. In addition, Blu-Ray supports 3D, and studios hope to push more Blu-Ray sales through 3D. However, the studios are at risk of killing 3D by flooding the market with cheesy post-production 2D-to-3D conversions.

Without the DVD profit engine, and without anything to replace it in the near term, studios are going to have to cut back on spending. That might mean betting more on blockbusters and their huge budgets, and cutting back the total number of movies they release each year, or maintaining the same number of releases and cutting back on budgets. Either approach means big changes for the movie industry.

The independent filmmaker's paradox

Several years ago, I ran a DVD distribution business. I didn't do a very good job, but sometimes you learn more from your failures than your successes. We were looking to license the home video distribution rights for a number of feature films, and worked with a company in Los Angeles that keeps track of all the independent films that are in production or completed and are looking for distribution. This was a few years ago, but there were more than 4,000 independent films produced each year without committed distribution deals. That's an enormous number by any measure. According to the Motion Picture Association of America, there were 610 movies released in the U.S in 2008. That's about the capacity of the U.S. theatrical exhibition system; they could of course show more films, but it probably wouldn't be profitable for either the exhibitors or the distributors.

Home video used to be a good outlet for a lot of titles that couldn't find theatrical distribution, but independent movie rental stores are all but dead, Blockbuster is "circling the drain", and the other leading rental chains are nearing, in or just existing bankruptcy. Home video is being driven by Netflix and Redbox; Netflix with a huge selection, and Redbox with a very small selection but low rental prices. DVD sales have dropped off due to the economy, and Blu-Ray is nowhere near picking up the slack. The big-box retailers like Wal-Mart and Best Buy no longer discount the new releases as heavily as they once did, slowing sales even further.

For an independent movie producer, the "conventional" outlets are becoming less and less viable. When shelf space is determined by how many discs can fit into a vending machine, the chances for small feature films to get distribution, let alone get noticed, drop to almost zero.

The Internet is seen by many as the savior of independent film, but that's where the filmmaker's paradox kicks in. You can produce and edit a movie today for less money than ever before. Distribution via the Internet is less expensive and more democratic than any method ever available to filmmakers. However, there's very little chance of making enough money from the Internet to cover the production costs of even a small independent film. So, even though it costs less to independently produce and distribute a movie than it ever did, it's no easier to turn a profit.

For decades, independent film financing has relied on an ever-changing assortment of starstruck investors, government agencies offering tax breaks and the families of filmmakers who want to help them make their dreams come true. Every year, there's a new set of players: One year there's money from South Korea, and the next year Germany becomes the big player. Canada and Louisiana compete to see which one can offer the most tax subsidies and the lowest overall production costs. Nothing, however, changes the fact that independent film funding is a sucker's game for the vast majority of investors. Subsidies allow you to save money, but you usually have to make some in order to get the benefits.

So what's the solution? It's attitudinal rather than structural. The Internet is not going to change into a profitable distribution channel any time soon. If you're making an independent film with the intention of making money, you're very likely to be disappointed. In you invest in an independent film with any expectation of making a return on your investment, you're also likely to be disappointed. The trick is to make and invest in independent films with no expectation of getting your money back. Make them because you want to tell a story, because you deeply believe in a subject, or you just want to pal around with actors and directors you admire. Take advantage of the lower costs of production and distribution to make films that otherwise would never have been made.