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Analysis of Movie Industry

Tamon Honda

Table of Contents

This paper is solely the product of Tamon Honda. The intent is to demonstrate my analytic abilities — quantitative and qualitative — as well as report writing. I have no special knowledge of the movie industry or any other entertainment industry. I just thought it would be a good topic for study.

This paper puts forward strategies for the movie industry. All findings are based entirely on data from IMDb.com, the Internet Movie Database, as of April 20, 2004. The used data consisted of only each movie's cumulative weekly revenue, budget, and genre(s). This report covers all movies released in 2002 and 2003. Therefore, though movies released in late 2001 generated revenues in 2002, they are not considered. Conversely, this paper does take into account 2004 revenues of movies of movies released in 2003. This paper does not encompass all 2002-2003 IMDb.com movies, only those that appeared on the opening day lists.

327 movies were released in 2004 and 2003. Of them, 53 did not have budget figures available on IMDb.com, so this paper ignores them for all calculations involving budgets and profits. Similarly, this paper disregards two re-released movies, Alien (originally released in 1979) and E.T. (1982). Since it is difficult to quantify how time diminishes the value of money, the Return On Investment (ROI) calculations for these two movies are not meaningful. Thus, the profitability and ROI calculations were based on the remaining 273 movies.

All revenue figures are from domestic box office sales only. Though usually significant, sources of revenue such as foreign ticket sales, DVD and videotape sales, TV broadcast rights, and movie merchandise (e.g. T-shirts, toys, and videogames) were ignored. Also neglected were the substantial marketing and distribution costs for the movies. According to the June 1, 2004 Wall Street Journal, approximately 30% of movie revenue comes from worldwide box office sales, 40% from DVD sales, 15% from "pay television" (perhaps pay-per-view), and 15% from broadcast rights. Marketing a major movie typically runs about $40 million, and the cost of making each movie print is in the $5,000 to $10,000 range. As a result, the profitability and ROI calculations are based solely on a movie's box office performance. Though this does not represent the entire picture, it is sufficient to provide a solid idea of each movie's performance. Furthermore, it provides a level baseline for comparisons.

As with any source of information, this analysis is only as accurate as the original data. While I am confident the data entry is mostly correct, the source may not be accurate. Any errors in IMDb.com - such as revenues and budgets - will propagate throughout this paper.

Finally, this paper categorized every movie into a Primary Genre. Despite the arbitrariness of labeling a particular romantic comedy as romance or comedy, for example, it was necessary for genre performance comparison.

High Quality Movies Are Worth the Investment

Movie making is a costly endeavor, fraught with risk. Predicting the financial success of any single movie an educated guess at best and a crapshoot at worst. Timing, competition, word-of-mouth, and luck play a bigger role with movies than with almost any other industry. One way to tilt the odds toward profitability is to make high quality movies.

Making movies is expensive. The average budget of the movies released from 2002 and 2003 was $35.9 million. Of these 273 movies, 164 made a profit, of which 146 had an ROI in excess of a 16.6% hurdle rate. (Most movies take about two years to produce. Two years at 8% interest compounded annually translates to 16.6%.)

At such a high cost, it would seem every movie would be made with high quality: scripts, screenplays, acting, directing, special effects, and so on. Unfortunately, such is not the case.

Defining Movie Quality

IMDb.com allows its users to rate movies from 1 to 10. The mean score for all movies released in 2002-2003 is 6.0 and the population standard of deviation is 1.3. As a point of comparison, the following movies rated 6.0: Empire, Stuart Little 2, The Transporter, S.W.A.T., Trapped, Murder by Numbers, Spy Kids 2: Island of Lost Dreams, and The Guru.

I awarded stars - 0 through 4 - based on their IMDb.com User Rating using the statistical grouping shown in Table 1.

The initial intent of the deviation segments was to provide the middle three star groups (1-, 2-, and 3-Stars) one full standard of deviation. Since the distribution of the star groups largely resembles a normal distribution, it was used without modification.

Movie Quality's Effects on Revenues and Profits

The next question was whether a movie's quality affects its financial performance. Examining the revenue and profit for an average 0-, 1-, 2-, 3-, and 4-star movie produces Figure 1.

Revenues steadily climb as quality improves. 0-star movies average $20.7 million, 1-star movies average $41.4 million, 2-star movies average $53.1 million, 3-star movies average $75.1 million, and 4-star movies average $153.0 million. Profits do not ascend as linearly as revenues, but the correlation remains. 0-star movies average a $17.0 million loss, 1-star movies average $5.6 million, 2-star movies average 6.8 million, 3-star movies average $33.2 million, and 4-star movies average $98.5 million. It is worth noting that the corresponding standard of deviation is very high, roughly equivalent to the average. Thus, the revenues and profits of movies are very volatile.

Nevertheless, the chances of making a profit increase with the quality of the movie, as shown in Figure 2. So too does the probability of a movie clearing a hurdle rate of 16.64% — two years of 8% compounded interest. (The average time to produce a movie is two years.)

Why Do Higher Quality Movies Have Better Financial Performance?

To answer this question, it is necessary to first examine the week-by-week revenue stream of movies according to quality. The overwhelming revenue pattern is for movies to begin strongly in its first weekend and deteriorate steadily thereafter. Thus, the two ways for a movie to enhance its total revenue are (1) to have a very big opening week and (2) to deteriorate weekly revenues slower than others.

Better quality movies do both. Figure 3 shows that not only do 4-star movies average greater peak weekly revenues, but also they retain their revenue generation abilities longer.

Figure 4 reinforces this notion. Better quality movies generate a smaller percentage of their total revenue from the first week and first four weeks. Not surprisingly, ROI (Return on Investment) climbs with quality. On average, 0-star movies have an ROI of -45.0%, 1-star movies 15.5%, 2-star movies 14.6%, 3-star movies 79.0%, and 4-star movies 180.9%.

Two possible reasons for the superior performance of higher quality movies are reviews and word-of-mouth. With many reviews released prior to the corresponding movie, the public make a selection based on informed opinions. They will flock to movies with positive reviews and stay away from movies with poor reviews. There is a bloc of people who will always be determined to see any particular movie, regardless of the reviews. However these people are drawn to bad movies, there are not enough of them to make them worthwhile investments.

While it may be true that the public will see any heavily marketed movie, for the studio, that is not enough. It must also concern itself with the movie's quality, which generally drives revenue and quality.

Invest in Small Budget Movies

A Look at High Revenue & Profit Movies

There is a popular notion that big budget movies are a good investment because they earn large revenues and profits. There is certainly some truth in this. From 2002 through 2003, 13 movies earned over $200 million in revenues. (See Table 2.) The average budget for these 13 movies was $94.2 million. An additional 38 movies earned over $100 million in revenues. The average budget for these 51 movies was $81.6 million.

In examining profits, a similar picture develops. 17 movies earned profits of at least $100 million, and their average budget was $83.2 million. Their aggregate ROI was 214%. (See Table 3.) An additional 26 movies earned at least $50 million. The average budget of these 43 movies was $61.4 million.

The reasonable conclusion from this is that earning large revenues and profits requires large budgets. Put simply, it takes money to make money.

Unfortunately, this accepted wisdom is misguided. While financially successful movies share the characteristic of big budgets, that characteristic cannot be confused with the cause. To put it another way, while it may be true that all felons smoke, it does not follow that all smokers are felons.

One test for this hypothesis is to determine how a movie's budget affects its financial performance.

A Look at Big Budget Movies

By contrast, Table 5 examines the other end of the spectrum. It lists the financial performance of movies that cost $7 million or less.

A Look at Small Budget Movies

Performing a similar analysis of movies with small budgets reveals a very different picture, as displayed in Table 5. Of the 23 movies with budgets of $7 million or less, two failed to turn a profit and one additional movie failed to clear the hurdle rate of 16.6%. 17 movies doubled their budget investments. The aggregate ROI of these 23 movies is 582.60%. Even excluding the phenomenally successful "My Big Fat Greek Wedding," the aggregate ROI remains very high at 336.39%.

Also, many of these low-budget movies have well-known and established actors. Sigorney Weaver starred in Tadpole, Jennifer Aniston starred in The Good Girl, Bill Murray earned an Academy Award nomination in Lost in Translation, and Charlize Theron won the Oscar for Best Actress for her role in "Monster." Established actors often take roles in these movies to expand their range, fulfill a promise, or because they have partial ownership. Whatever the reason, they earn a pittance compared to big budget movies, so their participation, however helpful, will be spotty at best.

One possible reason for the success of small budget movies is that the stories are better developed than their big budget counterparts. Knowing they cannot rely on big stars and special effects wizardry, producers and writers spend more time strengthening the script and the concept. Their initial audience, which tends to be more adventurous, initiates word-of-mouth campaigns.

Movies that fare poorly may not appear on the IMDb.com weekly opening lists. If so, this would explain the consistently positive performance of small budget movies: Only small budget movies that did well appear on the list, along with all big budget movies.

Even though smaller budgets carry smaller risks, they can carry huge rewards and may very well be more reliable investments than their big budget counterparts. Thus, as an investment, they deserve serious consideration in the fickle movie industry.

Take Advantage of the Trends

Just as there are trends for all movies, there are trends characteristic to specific segments. One strategy is to release a movie in order to comply with well-established trends. A riskier but perhaps more rewarding strategy is to operate against one or more components of the trends. In either case, it is crucial to identify the applicable trends.

Firstly, Figure 5 shows there are general week-by-week revenue patterns. The average weekly revenue is $167 million. The highest weekly revenues are the first and last weeks of the year, $337 and $315 million, respectively. The summer weeks - mid-May through the first week of September (Labor Day) - movie revenue averages $206 million. The summer spree lies between two slow periods. Weekly movie revenues average $133 million from February thorough April and $104 million from the second week of September through mid-October.

The reasons behind these trends are obvious: Year-end movie revenue is high because of family get-togethers for the holidays. Family reunions and students on summer breaks drive movie revenue from May through Labor Day. Neither pace is sustainable. People temporarily tire of movies, resulting in the lulls between the hectic periods.

Genre Analysis

This is part of the strategy of when a particular movie genre will be released. As displayed in Figure 6, Action/Adventure movies somewhat mirror the entire industry. In general, the most popular and successful movies are released over the holidays and summer, when people tend to have more time to see them. Comedies, dramas, and romances have somewhat constant revenue streams throughout the year.

Interestingly, "others" - primarily documentaries - do well in the slow periods. This may be because documentary fans are so devoted: While fans of other genres will attend when convenient, documentary fans will make the time. If so, the spring and fall are good times for their release. There's less competition, so there's less advertising clutter for a documentary's marketing plan.

Combining the information contained in Figures 7 and 8 reveal hidden characteristics of movie genres. Though Action/Adventure movies average the highest revenues, $94 million, and a respectable 23% ROI, they do average the highest costs at $72 million. Comedies, dramas, and family movies have nearly identical costs ($35 million, $35 million, and $37 million, respectively), but comedies have substantially higher revenue ($65 million vs. $37 million and $40 million) and higher ROI (46% vs. 5% and $8%). Like comedies, horror movies have a healthy ROI - 34% - good revenues and profits - $45 million and $15 million, respectively - and, at $29 million, moderate costs. Romances financially perform similarly to horror movies ($39 million revenues, $14 million profits, and 35% ROI), but unlike other genres, they make a significant portion of their revenues later. Romantic movies generate the smallest percentage of total revenue in the first four weeks, 47%. The next smallest, dramas, accumulate 72% of their revenue in the same period.

A large portion of all movie revenue comes early. For that reason, the distributors must market the movies heavily before their release to create excitement on opening weekend. However, a significant part of romantic movie revenue is earned after the fourth week. Thus, the potential audience may be receptive to a second marketing effort. An advertising campaign, filled with positive reviews on approximately the third week of release, could be very effective.

Audience Analysis

If trends exist among movie genres, it makes sense that they exist among the target audiences as well. Before proceeding, it should be made very clear that the target audience for each movie was selected arbitrarily. Unlike the genre, which was chosen from a list on IMDb.com, the author of this paper made up categories (Baby Boomers, Families, Gen X & Gen Y, Kids, Seniors, Teens, Teen Girls, and Women). There are doubtlessly more refined and sophisticated audience segmentation methods. This paper uses this one because of its simplicity. Also, some movies transcend its audience. For example, 2003's Finding Nemo was listed as a Kids movie despite its broad appeal.

One trend that is immediately apparent in examining Figures 9 and 10 is that movies aimed at younger audiences (Gen X, Gen Y, Kids, Teen Girls, and Teens) average high profits and strong early attendance. Teens and Teen Girl movies show extraordinary ROIs (139% and 173%, respectively). Of course, many of them are released in the summer, when teenagers have free time. Still, it is remarkable that all 15 movies targeted at Teen Girls or Teens were in the black.

The 49 movies aimed at (Baby) Boomers fared poorly, especially in profitability. One possible reason is that there aren't many people in this demographic who are willing to see movies that do not appease their children. Women's movies did respectably well. Perhaps they were weaned on Teen Girls movies years ago, they now gravitate to Women's movies with more mature stories. Though there were only eight movies in this study, they created a 65% ROI.

Movies that aimed at the Generation X and Generation Y on average did not perform outstandingly. However, it is the largest demographic group, with revenues surpassing $10 billion, nearly five times larger than any other segment. Thus, despite the apparently lowly financial performance and fierce competition, Gen X and Gen Y is still the demographic segment studios covet most.

Going Against the Grain

Most movies can be lumped together in easily separated groupings. Two notable movies that were classified in little-used categories were Chicago, 2002's Oscar winner for Best Picture, and The Passion of the Christ, released in 2004. Both were well-made movies in genres badly underrepresented in recent years, musicals and religion, respectively. Their astonishing revenues, $171 million and $330 million (and still counting) prove that movies can do well by not following everyone else.