Most people have seen at least one movie from Hollywood, likely more because watching movies is prime entertainment and we all enjoy being entertained. Long after you have seen the movie, you might wonder about how does the economics of Hollywood work? You enjoyed the movie, but how does Hollywood make money? One person who works in the industry offers insights in the book The Hollywood Economist – The hidden financial reality behind the movies by Edward Jay Epstein published by Melville House, NY, 2012.

Over the years, for 50 years there had been 6 big studios – Walt Disney, Warner Bros, Universal, Columbia, Paramount and 20th Century Fox, although in the past decade Walt Disney bought Fox and recently Paramount bought Warner Bros. to bring it to the big 4. Universal is owned by NBC which is owned by Comcast and Columbia is owned by Sony. Each of the big 4 have vast libraries which is one of the reasons why they will be solvent for a long time to come. In the case of Warner Bros, the Time Warner library has more than 45,000 hours of feature movies, cartoons, TV episodes dubbed or subtitled in more than 40 languages that it licenses to pay-TV, cable TV, satellite telecasters and TV stations in more than 175 countries. In 2009, the division grossed more than $2 billion. All those movies could be streamed.

The unwritten rule in Hollywood and its real genius is understanding that its audience prefers illusion to reality.

If you think about the big 4 companies, they prefer films that have a projected box office of at least $150 million. The reason is that a studio has only a limited number of slots for its releases at multiplexes and has to fill them with projects, whether profitable or not, that generate maximum revenue.

Consider the smaller film the Indie film. To raise the money to shoot a film, the producer must either find an outside investor, an equity investor or get a bank loan. To get a bank loan, an indie sells the distribution rights to foreign territories and then uses the contracts to borrow from the banks.

Foreign pre-sales if the producer is fortunate could provide up to 80% of the funding. The next step is which country around the world provides the best subsidies, as the subsidies and tax credits add up to 30% of the budget.

The producer buys a completion bond from an issuer such as Film Finance. The company, to reduce the risk, will insist on certain conditions. An example is for a $10 million film; the completion bond takes a 2.6% fee or $260,000. The conditions tend to be from the bank loan, $1 million has to be in an closed account for contingencies and $200,000 for deliverables to be held in an escrow account.

Banks will lend no more than 80% of the face value of the collateral. The bank will have a fee of 3% or $264,000. In addition, the bank will insist the producer put in an escrow account 18 months of interest.

In the end, the producer will have $5 million to make his $10 million film and will need an investor or equity partner and a lot of luck because thousands of films are submitted to film festivals every year, not all are chosen.

Linking to dividend paying stocks, when you view technology and movie industry you see that sometimes technology opens up movies and revenue opportunities; sometimes it opens up movies and decreases revenue opportunities; while the public enjoys entertainment and the movies, as an investor you need to ask how do you win?

There are more questions than answers, till the next time – to raising questions.