Blockbusters: Hit-making, Risk-taking, and the Big Business of Entertainment

by Anita Elberse

  Let’s look at the companies’ side first. It is not a coincidence that by far the biggest player in the world of video games at the time, EA, offered a fixed-fee payment while the two less powerful studios, 2K Games and Microsoft, proposed that James share in the upside. As the market leader and the studio behind the game with the highest level of exposure and a cover spot that is in high demand among athletes, EA can afford to be less aggressive in recruiting talent to endorse its game. “Being on the cover of an Electronic Arts game is great exposure,” said Carter about the opportunity, pointing to the value of, as he put it, “LeBron’s face” being “in millions of homes around the country.” Microsoft, meanwhile, was trying to grow its Xbox Live platform, so the company may have felt that it needed to sweeten the deal for James in order to compete with producers of better-selling games. If its game with James succeeds, however, Microsoft will end up paying a heavy price for its proposed compensation structure.

  Sharing revenues or profits with an endorser is especially problematic for firms in the entertainment industry, where a few hits typically need to make up for the losses on a larger number of failures: a content producer will want to hang on to all the profits of a rare blockbuster hit. This is why most companies enlisting creative talent will generally prefer the fixed-fee structure over both other compensation options. And this is why, in the event they have to choose between those two less-than-ideal options, companies likely prefer the sort of bonus-structure model offered by 2K Games over a revenue-share model. Although this approach to compensation forces the company to increase its spending the more successful its products become, the total potential payment is capped.

  Superstars, however, may take an opposing view of these compensation models. As they progress through their career life cycles, popular performers tend to shift their emphasis from creating to capturing value. The more wealth they have already accumulated—or the more confident they are that significant rewards are on the horizon—the more risk they are generally willing to take on when accepting new assignments. Betting on revenue-sharing (or profit-sharing) agreements then becomes quite attractive, because these kinds of contracts allow the talent to capture a significant share of the value that they themselves bring to projects. This is why, all else equal, most established superstars probably prefer a revenue-sharing model.

  (If this “save first, take risks later” idea sounds like the opposite of what people in other careers are usually taught about how to manage financial risk, that’s because those rules hardly apply to creative workers. It might be fine for newly minted lawyers and doctors to, say, buy stocks rather than deposit their salaries in a savings account, but they are expected to have much longer careers and can therefore afford to take risks early. Athletes, actors, and other performers have more pressure to make their early earnings last, in case their careers are as short as those of most of their peers.)

  With such different perspectives on what deal is right, it’s no wonder that stars and the companies they work for often find themselves in a tug-of-war. As performers such as LeBron James gain in power and achieve wealth at an ever-younger age, they can accept more risk in subsequent career moves and push for ever-larger rewards. That dynamic, in turn, can seriously erode the profits of the firms that rely on those performers to produce or market content. Yet even if most managers in entertainment businesses worry about their ability to compete for the most sought-after talent, they often find that they can’t afford not to compete for that talent—at least not in the long run.

  Hollywood finds itself in precisely this tug-of-war. In recent years, the major studios have worked hard to curtail spending on star actors. So-called back-end deals with stars have evolved, explained Horn: “It used to be that an A-list star would get, say, $15 million to $20 million against anywhere between eight and ten percent of the first-dollar gross revenues, meaning the revenues after exhibitors take their share. Now, we might still give them their up-front fee, but then we make sure we first get all our costs back and our overhead and interest, and we pay ourselves a modest distribution fee. What’s left after those costs are deducted becomes the profit pool of which creatives, including the director and the actors, get a certain share.” A shift away from the model that is most advantageous for the superstar, in other words. Hollywood studios’ love for franchises involving comic-book characters and other mega-selling properties also helps rein in star power—and thus star salaries. “With Harry Potter, the book is the movie star,” Horn said. “When you have a film based on a property that everyone knows, you don’t need a big star to sell tickets. You need good actors, but they don’t have to be stars.” There is no need to feel sorry for the A-listers anytime soon, though: for instance, when the dust settled after the box-office run of Marvel’s The Avengers, Robert Downey Jr. reportedly received $50 million for his role as Tony Stark.

  * * *

  It ought to come as no surprise that LeBron James ultimately chose the offer from Microsoft Xbox over the proposals from EA and 2K Games. Although a multitude of considerations went into that decision, the fee structure played a key role. (In 2013, James subsequently signed with 2K Games, finally making his debut as a cover athlete for the game NBA 2K14.) Explaining his client’s enthusiasm for the revenue-sharing deal, Carter said: “For LeBron, an up-front payment of a few million dollars does not make a difference. It does not drive his choice. That money just adds to the pile of money he already has—it makes it a slightly bigger pile.” He added: “For me, it can determine what kind of floor I can get in my kitchen. But I cannot think about what is best for me—I have to think about what is best for LeBron. And we are trying to build a billion-dollar business.”

  It sounds a bit like Justin Timberlake playing Sean Parker in The Social Network—“A million dollars isn’t cool.… You know what’s cool? A billion dollars.” But Carter is on to something here—after all, Michael Jordan’s Nike product lines alone reportedly yield revenues of several billion dollars each year. Imagine having even a tiny slice of such a large business—that is increasingly what superstars like James are aiming for. Among entertainment industry insiders, rapper 50 Cent’s endorsement deal with vitaminwater is a much admired example: because he negotiated an equity-sharing agreement before the beverage brand took off and its parent, glacéau, was sold to Coca-Cola, he is thought to have made well over a hundred million dollars from that deal alone. Spurred on by such successes, IMG and Sharapova have also pursued these sorts of opportunities. Her most eye-catching deal to date is an eight-year, $70 million agreement with longtime sponsor Nike, in which Sharapova receives a percentage of the sales of a line of dresses she herself helps design.

  The high rewards that are up for grabs for stars in the entertainment industries create a vibrant, highly competitive market full of supremely talented performers. Businesses that rely on top-ranked talent will experience strong advantages in the marketplace. But because true superstars can use their power to secure unprecedented levels of compensation, they are able to capture much of the value they add. The result is that those superstars—and not the firms that pay their wages—often emerge as the biggest winners.

  Chapter Five

  WILL DIGITAL TECHNOLOGY END THE DOMINANCE OF BLOCKBUSTERS?

  How do you change the fortunes of a company that went from being called Time’s “Invention of the Year” in 2006 to one of the magazine’s “10 Biggest Tech Failures of the Last Decade” a mere three years later? Robert Kyncl, YouTube’s global head of content, thought he had the answer. It was October 2011, and Kyncl was putting the final touches on a plan that promised to revolutionize the world of online video—and perhaps even of television more generally. Kyncl and his team had come up with an idea to create more than a hundred “channels” with original content on YouTube. Hoping to jolt the creative community into action, they had earmarked a reported $100 million in advances in an attempt to solicit new material from producers, actors, musicians, comedians, and other talent.

&
nbsp; The move was a significant departure for the company. Created in 2005, YouTube had built its name by enabling millions of everyday users to freely upload, share, and watch videos. Co-founders Steve Chen, Chad Hurley, and Jawed Karim reportedly came up with the concept for YouTube in early 2005 when the three friends, hanging out at a dinner party, realized they could not easily let others view the short video clips they had recorded that evening. They began working to create a solution and, in May of that year, a beta version of the site went live with several dozen videos shot by the founders and their friends. The site initially gained little traction, but that all changed when fans posted a Saturday Night Live skit, Lazy Sunday, in which Chris Parnell and Andy Samberg rapped about going to an afternoon showing of the children’s movie The Chronicles of Narnia (with masterful prose such as “Yo Samberg, what’s crackin’? You thinking what I’m thinkin’? Narnia.”). The video quickly went viral, ultimately collecting five million views before it was taken down at NBC’s behest—but not before it had given YouTube a huge promotional boost. Within months, the site was streaming more than a hundred million clips a day—amateur recordings of sneezing pandas, Segway-riding chimpanzees, teenagers singing along with pop songs, and snowboarders wiping out, but also music videos, sports highlights, clips and “mash-ups” of movies, television series, and other copyrighted content.

  Google acquired YouTube for a jaw-dropping $1.65 billion just over a year after its birth. “We’re in the middle of a shift in digital media entertainment,” said chief executive officer Hurley at the time. “Users are now in control of what they want to watch and when they want to watch it. They decide what rises to the top, what’s entertaining.” By 2011, YouTube was the behemoth of the online video space, with eight hundred million unique users a month across the globe, and more than three billion views a day. Living up to the site’s motto, “Broadcast Yourself,” users uploaded forty-eight hours’ worth of new videos to the site every minute.

  But despite its wild success in accumulating viewers and views, YouTube struggled mightily. It drew the ire of media companies for, in their eyes, failing to obey copyright laws. Advertisers remained wary of the vast amount of user-generated content on the site: in 2008, for instance, only an estimated 3 percent to 10 percent of YouTube videos were monetized through advertising. And for all its popularity with users, the average YouTuber only spent a paltry fifteen minutes per day on the site, compared with the four to five hours daily the average American spent watching television.

  Industry insiders expressed strong doubts about YouTube’s ability to generate profits. “The future seems bleak for the user-generated material players unless they can secure access to sufficient independently produced professional content,… or they adapt their model to accommodate a pay-to-download or pay-to-view approach,” wrote one analyst in 2010. Another argued: “Google needs to make a decision about YouTube: keep the status-quo and continue to support and grow an ever increasing number of streams via advertising to break even or change the culture slightly to a user-paid model and begin to recognize benefits to the bottom line.” Hired away from video rental company Netflix where he negotiated deals with film and television studios, Kyncl initially concentrated on strengthening YouTube’s streaming-movie-rental business, the company’s first foray into paid content, which had been announced in early 2010. The service, launched with titles from the Sundance Film Festival, never quite managed to compete with rival offerings like the iTunes Store and Netflix.

  Now the company’s hopes rested on the new “YouTube Original Channels.” The concept of channels itself was not new: established media companies such as the Associated Press, CBS, and Warner Bros., as well as homegrown YouTube stars, already offered videos through their own channels on the site under YouTube’s “Partners Program,” splitting advertising revenues with the site. “This is very much how we see the YouTube platform—with channels helping audiences find the content they love in a really smart way, and make it deeply personal to them,” Alex Carloss, YouTube’s head of entertainment, told me. However, Kyncl, Carloss, and their colleagues hoped the company’s richly funded new initiative would encourage more established writers, directors, and producers to create original content for the site. “What we do is commission channels,” declared Kyncl. “We don’t tell people how to program the channels. We have certain volume requirements … but we are not making show-by-show decisions.”

  “It feels like a tremendous opportunity to tell the creative community that there is room for an awful lot of players in this space,” Carloss said. To help develop their ideas, content creators could apply for up to several million dollars in funding, in the form of advances against their share of future advertising revenues. In return, channel owners were required to supply a minimum number of hours of programming each week. The expectation, Carloss explained, was that content creators would upload “anywhere between twenty and sixty hours of content over the course of a year.” He added: “That can be original content—that is what we are funding—but it also can include curated content which speaks to the voice of the channel, or it could be archival library content.” The creators would retain ownership, but YouTube would have an exclusive right to the content for a year. “We handle distribution—the creators are responsible for everything else,” said Carloss. “YouTube allows them to find their audience wherever it may be. Their job is programming their channel and driving viewership.”

  Reflecting on the evolution of television, Kyncl commented: “People went from broad to narrow … and we think they will continue to go that way—spend more and more time in the niches—because now the distribution landscape allows for more narrowness.” He believed people would prefer niche content because “the experience is more immersive,” adding: “For example, there’s no horseback-riding channel on cable. Plenty of people love horseback riding, and there’s plenty of advertisers who would like to market to them, but there’s no channel for it [on traditional television], because of the costs. You have to program a 24/7 loop, and you need a transponder to get your signal up on the satellite. With the Internet, everything is on demand, so you don’t have to program 24/7—a few hours is all you need.” Carloss agreed: “There are many examples of narrower content types that we can focus on. A lot of these channels would never see the light of day in the traditional television infrastructure—they are just too specific—but on YouTube they are a natural fit.”

  * * *

  Why would YouTube, long known for its vast assortment of freely acquired amateur videos, switch to making a sizable bet on content development? How likely is it that YouTube will get a solid return on its considerable investment in niche channels? And will television come to look a lot more like YouTube does now—will we see a future in which everyone can be a content producer and tailor their products to thousands if not millions of niches?

  These questions go to the heart of a hotly debated issue in entertainment circles—whether digital technology will spell the end of blockbusters, and thus of the effectiveness of blockbuster strategies. Some argue that the rise of online channels, driven by powerhouse sites like YouTube, is a sign that the “old” rules of the entertainment business soon will no longer apply. But the reality isn’t quite so simple; indeed, if the lessons emerging from YouTube’s evolution about the future of entertainment are anything to go by, the old rules may be more applicable now than ever. It turns out that there are laws of consumer behavior that both explain some of the site’s biggest challenges in finding a sustainable business model and accurately predict the struggles experienced by many other businesses in popular culture. Every manager in the entertainment industry should be acutely aware of these laws, for one because they make it apparent that blockbusters will become more—not less—relevant in the future.

  To see why, let’s start with the basics. What explains the emergence of online video in the first place? The answer is simple: lower costs. The rise of digital technology reduces the cost of doing busines
s in two major ways. First, digitization lowers the cost of selling goods. More specifically, new technologies reduce the costs that sellers incur when distributing products and collecting payments. Economists call these “transaction costs”—think of activities such as adding variety, communicating choices and prices to consumers, and managing assortments. Such tasks tend to be much less costly in digital environments than they are in more traditional settings. Online retailers do not face the shelf-space constraints that hamper bricks-and-mortar stores, and Internet businesses can use recommendation engines and other technologies to effectively manage their assortments.

  Second, digital technology lowers the costs of buying goods. The costs that buyers incur in locating a seller and completing a transaction are often referred to as “search costs.” These include activities such as finding products that match one’s tastes, obtaining information on prices and other product attributes, and engaging in a transaction. Electronic marketplaces often significantly lower the amount of “effort” that buyers have to exert to accomplish these kinds of tasks. For instance, we can use search engines to quickly find content, rely on one-click options to complete a transaction online (rather than having to provide our credit-card details every time), and easily have products delivered to our homes.

  Decreasing transaction and search costs affect almost all industries in one way or another. But the growing ubiquity of digital technology has truly transformed the entertainment sector. That’s because in that sector digitization also lowers a third cost of doing business: the cost of producing and reproducing goods. Advances in cameras, green-screen technology, and editing software now enable professional filmmakers to resort to complex technical effects, shooting scenes that were previously unimaginable or, at the minimum, nearly unaffordable. Similarly, aspiring musicians can now record songs using no more than a laptop and a microphone and achieve a quality that was formerly available only in professional recording studios—and at a fraction of the cost. Many entertainment products can be fully digitized, including television programs, recorded music, books, and sports highlights. That, in turn, makes it possible to create an endless number of inexpensive reproductions and distribute them cheaply via digital channels (rather than having to ship them in physical form). Unfortunately, this feature of entertainment products also triggers illegal distribution on a massive scale, since the same forces that make recording and sharing entertainment goods cheaper for everyday consumers make it easier for pirates, too.