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Hollywood Panicking with Its Own DVD Sales Slump; $14 Billion Gone Like Magic

from – Hollywood’s biggest slasher story isn’t playing at any theater near you. It’s hitting the industry’s corporate suites, where the sacking of studio executives has reached epidemic level.

As evidenced by Disney’s recent firing of its studio chief, Dick Cook, and Universal Pictures’ dismissal Monday of chairmen Marc Shmuger and David Linde, Hollywood is in a state of panic-producing turmoil.

It used to be that Hollywood’s corporate parents could stomach a dry spell from their studio managers. But as DVD sales have collapsed by as much as 25% at some studios, access to outside financing has vanished and production and marketing costs remain sky-high, media companies are cracking under all the pressure.

As the lineup of newly elevated studio executives scramble for solutions, expect an even greater emphasis on so-called “branded entertainment”: sequels and movies based on toys, old television shows and other familiar themes. Movies already in development include one based on the View-Master children’s toy and an adaptation of the board game Battleship, scheduled for release July 2011, the same month as a third “Transformers” film. There also will likely be far fewer adult dramas and less reliance on movie stars — many of whom can no longer draw ticket buyers, and are seeing their guaranteed salaries slashed.

“You’re not going to get away with the old business model,” said Hal Vogel, an entertainment industry analyst who runs Vogel Capital Management. “They still haven’t found a new business model to replace the old one.”

In addition to the recent shake-ups at Disney and Universal, Paramount Pictures in July told two of its most senior production executives — John Lesher and Brad Weston — that their services would no longer be needed. In August, MGM’s board showed Chief Executive Harry Sloan the door. On Monday, Disney promoted Disney Channel Chief Rich Ross into its top studio job.

Half the town’s major studios — Warner Bros., Sony and 20th Century Fox — have not suffered any significant leadership shake-ups this year.

“There’s been more change in the last 18 months than in the preceding 18 years,” said Mark Gill, CEO of the Film Department, an independent film finance company.

Like a baseball manager who is asked to transform an underachieving team into a playoff contender in a single season, studio executives are given little time to work their movie magic.

“The world we live in now is so bloody public,” said Bill Mechanic, the former chairman of Fox Filmed Entertainment and now an independent producer. “Every decision is magnified. Every decision is blown up on a global basis almost as soon as it happens. People start becoming defensive about their jobs. When you’re always doing things on the defensive, it’s very hard to do that job.”

In a business largely governed by artistic intuition, ups and downs are inevitable, but there’s far less margin for error today. Many analysts and industry veterans cite the recent and unexpected decline in DVD sales as the ignition point for the current unrest.

For years, DVD sales, coupled with the growth in international markets, compensated for box office losers. On a typical movie, DVD revenue accounts for about half of a film’s income, with the remainder split evenly between theatrical receipts, both domestic and international, and television, both pay and free channels.

But as the global economy tanked, so did DVD income. According to Digital Entertainment Group, DVD sales fell 9% in 2008 and were off 13.5% in the first half of 2009. The DVD ledgers are equally bleak overseas; owing to widespread piracy, some studios essentially have closed DVD operations in the once-profitable Spanish and South Korean territories.

Though new businesses such as digital downloads and video-on-demand are growing fast, they have come nowhere close to making up for the decline in disc sales. At the same time, foreign monopolies in paid television have driven down the formerly generous license fees paid to American studios for cable and satellite reruns, while increasingly popular local language productions (movies in Japanese made for Japan, in other words) have cut into the international box-office returns for U.S. productions.

Paramount Pictures, the only movie studio to report its finances separately, has seen its profits fall consistently. While revenue was growing until this year, Paramount’s operating income has fallen like a boulder, down 22% in 2007 and 75% in 2008 until it swung to a loss of $148 million in the first half of 2009.

As profits vanish, new capital has become as unattainable as the best picture Oscar.

In the decade’s early years, high-net worth individuals and cash-flush hedge funds poured billions into Hollywood, backing independent productions and co-financing big-budget popcorn movies. But as those investors lost fortunes in the markets (and, too often, on dead-on-arrival movies), they pulled back on their show business speculating, forcing the studios to put more of their own money at risk — like homeowners undone by their mortgages.

“It does something radical to an industry when $12 billion to $14 billion suddenly goes away,” said Gill. “That places an enormous strain on the system. And nothing is replacing it. It used to be ‘let’s get the Germans’ and then the Germans went away, so it was ‘let’s get the Japanese’ or ‘let’s get the insurance companies.’ There was always going to be somebody else. Now it looks like it’s not going to be someone else.”

When times were flush, the studios spent like sailors on shore leave, handing out lavish producer deals, flying private jets, adding millions in overhead (including their own compensation) and pouring fortunes into poorly executed projects like Disney’s “Bedtime Stories” and Universal’s “Land of the Lost.”

“The money that came into the business from new markets and enhanced [ancillary] markets mostly went to increasing negative costs, marketing costs and overhead, and not improving profit margins,” said former Paramount Chairman Jonathan Dolgen.

The studios have stuck any number of thumbs into their leaking dike.

Over the last few years, several closed down or dramatically pruned back their specialty film divisions, units such as Warner Independent Pictures, Paramount Vantage, New Line Cinema and Miramax Films that were devoted to highbrow fare and modestly budgeted genre titles.

Although the studios will occasionally devote more than $200 million producing high-profile titles like the “Harry Potter” and “Spider-Man” sequels, executives are trying to spend less on star compensation, especially since some of the town’s highest-paid stars — $20-million actors such as Eddie Murphy, Adam Sandler, Russell Crowe — have proved over the last year that their names on the marquee hardly guarantee that crowds will come.

As studio executives and their boardroom bosses labor to eliminate risk from what is inherently a risky business, they are steering their production funds into movies they believe have built-in sales hooks — a fruitful strategy with the “Pirates of the Caribbean” and “Transformers” global blockbusters.

In addition to the “Battleship” and “View-Master” films, that familiarity-doesn’t-breed-contempt slate includes movies based on Lego, the video game Asteroids and the toy Stretch Armstrong. Film lovers may not rejoice, but it might buy the studio chiefs some job security — at least for a couple of months.


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