the unusual economics of the film industry

Per Alex's kind introduction yesterday, I'm his brother Nicholas and I'm guest blogging for the week.

I'm not an economist but if I have learned anything from my brother (and i have learned lots) it's that economics affects us all.   And i don't mean that in the obvious way that the economy affects us all.  I mean that the academic and esoteric economic theories that are studied in graduate university courses have a very real world and every day practical application.

One interesting thing that I've always found about the film business from an economic point of view is that unlike in any other business I can think of, the cost of manufacturing the product has no affect on the purchase cost to the consumer.  For example Honda can make a cheaper car with less features and cheaper finishes than BMW without losing all of their customers to the superior car because they sell their product for less.  You spend less to make something, you charge less for it.  Makes complete and obvious sense.  Not so in the film business.  I am an independent film producer and I make films that typically cost somewhere between $5M and $10M.  But when I make, say, an $8M film it has to compete at the same price level as the studios' $80M or $100M film.  It costs the consumer the same $12 at the multiplex (and whatever it costs to rent a DVD from Blockbuster these days) for either film.   There is no price advantage to the consumer for choosing to see a less expensive film.  This naturally makes it terribly difficult for smaller films to find an audience.  I find this quite fascinating and I can't readily think of another industry like it. 

A few years ago Edgar Bronfman Jr, during the time his family briefly owned the Universal film studio, suggested that theaters actually charge different admission prices for different pictures so those films that cost less to make had correspondingly lower ticket prices than the mega-budget studio pictures.   He was roundly ridiculed by the industry.  But truth be told I actually think the less-the-warm reception his proposal received had more to do with the fact he was an 'outsider' who had bought his way into Hollywood than on the actual merit of the idea itself.  Sound like good economic practice to me.


That's an interesting point. I've tried to think of any industries to compare it to, the most obvious being the music industry. But while the price of a CD or digital download has been essentially standardized, there is great disparity in the price of a live performance.

On the other hand, what would the effect be of introducing different price levels at your average mega-plex? Moviegoers tastes are very subjective. No doubt many enjoy big-budget films with big-name stars attached. However, there are also many who loathe such films, and the majority, of course, who just like a good film regardless of the budget. What would different-tiered pricing signal to the average moviegoer? It could inadvertently pass along the message that it somehow isn't as high a quality as the $12 movie. While the cost to see a movie has certainly increased it is still a relative bargain for roughly 2 hours of entertainment. In fact, for many people the true cost is the time it takes to see the movie, rather than the price itself. The lower price would signal that the movie is in less demand, and less worth a moviegoers time, and they may pass just on price alone.

I have always figured that this fact would serve as a relative disadvantage for the more expensive film - the end product is roughly the same (90 - 120 minutes long) but the $100M film needs to do "something" that attracts 20 times as many viewers than the $5M film.

So what is the "something" that very, very expensive films do differently? Is it money mostly spent on hiring a well-established cast? Are people really drawn to movies by very expensive special effects? For my part, I can't usually tell the difference between a $5M and $100M film, except that the former is likely to be more story-driven.

This is an interesting perspective. I never really thought about it, but it does sound like staunch industry tradition is stifling free-market pricing here in a sense. Bronfman's suggestion would be a breakthrough, but even better: let the market set the price. A low-budget but highly reviewed and widely anticipated comedy like The Hangover shouldn't charge less for tix just because it cost less to make--it should charge its profit-maximizing equilibrium price. Now that I'm really thinking about it, it seems utterly outrageous that movie tickets all cost the same!

I work in the games industry which has similar economics, at least in the area of big budget (what are called 'AAA' games in the industry) PC and console titles. Most console games that see a boxed retail release sell at the same price point but budgets can vary widely (though perhaps not as widely as in film). This gives the games industry similar dynamics to the film industry: it's a hit-driven business where big budget titles have to target a broad demographic and so risk being 'lowest common denominator' entertainment.

There are other segments of the games industry that are growing in importance where the economics are different - casual games, low budget downloadable 'indie' games, iPhone games, etc. There seems to be a little of this going on in the movie industry (independent movies made for a low budget and released on the web for example) but the distribution model doesn't seem to be as developed as for games.

I'm going to start with questions rather than comments:

1 - do the theaters have the ability/rights to charge different prices for different films or do their agreements with studios demand that all films be priced the same?
2 - do the theaters pay the studios for the rights to show the movies?
2a - if "yes", is the cost for the rights different for different movies?

Assuming "yes" to all three questions above, then I think it makes a LOT of sense to charge different prices for different films with the objective to maximize % of seat fill for every showing on every screen in the house. I'm not sure that the answers are all yes though.

Imagine charging $20/ticket on opening weekend of Transformers 2 as well as $5 for a lesser publicized film in its 3rd week.

What about the idea of charging different prices for different film times. $2 Tuesday was a hit at a local theater when I was a kid. We all know that matinees are cheaper. What about if you extend this & say that the 7:30 showing is $20, the 5pm is $12, the 10pm is $15, the 12:30am is $10.

It does seem that theaters could maximize their profits & films could maximize "Box Office Sales" figures with some creative pricing.

Perhaps I should note one experiment in variable pricing that's come up recently. Lionsgate released Clive Barker's "Midnight Meat Train" exclusively to discount theaters, which normally do not screen first-run features. But this was a clunky substitute to true variable pricing because it limited the number of theaters that could show the film.

"Prices have everything to do with supply and demand, and nothing to do with the cost of manufacturing."

Isn't the cost a component of supply and demand? I'm not going to build a $400 widget if the demand is only willing to pay $300. Instead I'll make a $250 widget and sell it for $300.

Does it matter that it costs a movie theater the same to show an $80 million picture as it does a $5 million dollar picture? Also, do moviegoers really think that much about production costs?

It's also a unique industry in that there is no assumption that you are actually going to like the product. You don't know what you are going to get and that's part of the experience. Let's say half the people will be disappointed. The other half do the marketing and advertising for the theater.

People aren't going to go see a cheap movie because it is cheap (except college students). If they are going to see it despite being cheap, why not raise the price? So, the theater wants everyone to make a $12 movie, and the studio tries to create Star Wars and Cars.

But, you can't raise it to the point people won't see it because they are your marketing army. So, maybe the price should go up a buck for each week it's in the theater.

Read Arthur De Vany's excellent *Hollywood Economics*. It lays out everything a layperson, academic, or insider would want to know about these things.

The unique thing about movies is that no two are alike -- whereas each "copy" of a certain make and model car are basically the same. (And most cars produced are highly similar, at least at the level of sedan, truck, SUV, etc.)

Thus, unlike cars where consumers know that they can be certain that they'll get more or less of some bundle of features -- air conditioning, power locks, etc. -- and trade these off against price according to their tastes, they are totally uncertain about whether or not a given movie has more or less of what they like. Because each movie is unique, they cannot know whether or not it's their cup of tea until they actually pay to see it.

So, they cannot say, "Well, compared to other movies, this movie costs less to see, so it's probably lower-budget, and so probably lower quality on average, but I'm willing to pay less for less."

They can only say, "I have no idea whether I'll like any of these movies, let alone which I'll like more than others. Since I can't tell which is lower-quality ahead of time, I won't pay any more or less for any movie compared to the others."

So we get uniform prices.

A separate question is why prices don't change over time -- once the theater can tell whether a movie is a blockbuster or a dud, i.e. which are in high vs. low demand. It could be a reputational thing, since customers will decry price "gouging." Unlike the case of the price of food or shelter after a natural disaster, though, there won't be shortages of a blockbuster -- there usually aren't *that* many people who want to see it at a given time.

Plus with multiplexes you can expand or contract the supply very easily to meet changing demand (e.g., close down four duds and now have four extra screens for the blockbuster). This obviates the need to raise prices to deal with a shortage.

"less features"?
I am sure you meant to write "fewer features".

Why is everyone confused why cheap-to-make films should have the same ticket price as the expensive-to-make films?

Does the lease on the building or the property taxes get any cheaper if you show a cheaper movie?
Does the staff get paid less money if you show a cheaper movie? Do cheaper movies require less staff?
Do you need to sweep the theater less or clean the bathrooms less for a cheaper movie?
Is the projectionist's wages, or the electricity and maintainance on the projector any cheaper for a cheaper movie?
Is liability insurance any less for the cheaper movie?
Is the capital investment on projectors and sound equipment and such less because you show cheap movies on the equipment?

And what about the opportunity cost? Every cheap seat they sell is one less expensive seat they can't sell. Unless there is some huge overcapacity

Basically, when you go to a movie theater, you are not paying for a movie - You are paying for the seat, service, and amenities that the movie theater provides. It is a service, not a product, and the cost of the service doesn't really change even if they where projecting TV static on the screen for two hours.

This is an interesting question. "Vehicle Driver" makes good points, but this weird pricing still holds in DVD rental/purchase.

I've always thought in music it would make more sense to let the content generator (i.e. the artist) set the price. The marketplace would be sort of like ebay, skimming off the top. Same for online distribution of movies.

"Note that movie theaters do already price-discriminate by having matinee discounts. Since they already discriminate based on time of day, why not also discriminate based on which film is showing?"

Price discrimination is charging different prices for the same thing, and two different movies are not the same thing.

And as Peter noted, even if you tried to price discriminate for a given movie, you'd incur higher policing costs to prevent people who bought a ticket for the cheap movie from walking into the expensive movie. You'd have to pay for ticket-takers to stand at every room, rather than for just one before you enter the labyrinth of rooms.

Even then it wouldn't work because theaters compete with each other to show the same movie. If theater A tried to price discriminate, nearby theater B would out-compete it by not price discriminating.

The matinee discount works because you can't do the arbitrage -- it's marked differently, so if you try to buy low and use it when it would be expensive, they'll catch you. Same with children's tickets -- if a middle-aged man tried to enter with one, he'd get caught.

Price discrimination is charging different prices for the same thing, and two different movies are not the same thing.

I'm not a micro person but not according to my recollection of various undergraduate textbooks. Goods can be similar (a first-class v. economy class air ticket or generic fizzy soft drinks v. Coca-Cola) but not exactly the same and the price difference can still qualify as price discrimination. In any case, my point was not to argue over the textbook definition of price discrimination but to respond to the argument that a business is not going to charge different prices for A and B when its production cost does not differ between A and B. Price discrimination shows this is faulty since under the most restrictive definition (one that I don't believe is accurate, though) A and B are the same but are still priced differently.

And as Peter noted, even if you tried to price discriminate for a given movie, you'd incur higher policing costs to prevent people who bought a ticket for the cheap movie from walking into the expensive movie. You'd have to pay for ticket-takers to stand at every room, rather than for just one before you enter the labyrinth of rooms.

Many other countries already do this by having ticket checkers by the door of the theater. Given the already high price of movie tickets, a theater could recoup whatever costs are incurred in this enforcement without too much trouble. What is interesting is that the opponents of variable pricing don't seem to be theater owners but rather film studios. That suggests these practical issues are not the main reason we don't have variable pricing.

Would the Coen Bros. sell twice as many tickets if they charged half as much?

I doubt it. Most lower budget movies are aimed at more elite audiences with more income.

If there was a big market in the U.S. for Spanish-language family films then, yes, I could see setting the price lower so a family of six could got to the movies for, say, $24. But working class Mexican-American families tend to like the same Transformers-style blockbusters as everybody else in the mass audience.

I'm sure you have many wonderful insights into the film industry, but you made a horrible comparison between Honda and BMW. The two companies are successful in very similar ways that are different from the rest of the auto industry.

Movie theaters have to give a cut of the ticket revenue back to the studio. The percentage starts out extremely high on Release Day (close to 100%, one theater owner told me) and then drops off over time. So if the theater owner charged less for an indy flick, the indy studio would get less money, and no one would win. (Unless of course halving ticket prices would more than double the turnout.)

As an aside, those high percentage kickbacks are the reason that concessions are so heavily promoted, and so overpriced. To the owner, the theater is little more than a concession stand with some movies playing down the hall to draw people in.

The Honda/BMW example is weak. Film makers do see to compete on things in the movie rather then on price after distribution.

For example, getting Halle Barry to take her clothes off is worth $500,000 to the producers. Getting an A list start is worth x dollars. Spending x on 3-D effects is worth x dollars.

Also I failed to mention, or make clear, that you do have some movie houses that are a secondary outlet. They show movies that are not new releases, but much of this has been replaced by DVD sales

Also DVD sales have fallen. Movies on demand - rented or bought and stored - seems to be the next distribution channel.

Then the question becomes how do you become part of a low overhead distribution chain and still break through the noise

Oberservations (some of which may be a little redundant):
* There are mulitple industries with high upfront cost and little or no manufacturing/distribution cost: film, software, book writing, money management, prescription drugs. In most cases, unless there are countervailing forces, the trend is towards a barbell concentration: a few large, expensive mass produced products combined a large number of very small independent/customized products.
* The nature of intellectual property is that the spoils concentrate with the few
* I suspect that the price elasticity of movies is very low (up to a point): thus cutting the price won't generate enough volume to offset the loss in revenues. There is also wide variances in what individuals would be willing to pay to see, and that would likely be unrelated to the production costs or mass appeal of the film.
* The high cost of mass produced films relate to either star ("brand") appeal or special effects.

I second what vehicle driver said. The way movie theaters adjust for supply and demand is through availability of seats for a particular film. They vary the number of screens it is being shown on, how many times a day it's shown, how long it plays, etc. Constantly adjusting availability instead of price.

I never thought about this before. I wonder what happens when you look at it as a problem of information. Reminds me of essays on how hard it is to find a good car on the used car market. Could Hollywood exist if there were movie ticket lemon laws?

The uniform pricing is for couples. I want to see the action film, my wife wants to see the period drama. If the period drama is $5 and the action film is $15 it complicates negotiations.

Surely this is true of books and music as well as film?

An album costs just the same whether it's recorded with 20 musicians, or one guy and a guitar.

See Paul Graham's excellent article on 'post-medium publishing' for the implications of this:

Tabarrok is confusing cost with demand. The car analogy doesn't hold, because the entertainment value of the movie to the viewer bears no consistent relationship to the cost of its production.

To put it another way, one might just as well ask why the indie movie producer doesn't charge a higher price, marketing his movie on the basis of its artistic quality to smaller audience of devotees, like luxury and sports car manufacturers do.

Basically, entertainment producers are marketing an unknown quantity (we don't know how good the movie/book/videogame is going to be) in an unreturnable fashion (you can't get that two hours of your life back). The industry coalesces around a price that it thinks is the highest that moviegoers will be willing to take a chance on.

As I understand it, the smaller budget movies generally do have lower prices for the theaters. Distributors negotiate a fixed percentage of ticket revenues with the theater as payment. Larger budget films guaranteed to draw more patrons demand higher percentages. Why this is not passed on to the customer is an interesting question. One factor is definitely enforcement costs are significant compared to the increased revenue from price discrimination with tickets. The other I think is that the theaters already have an effective alternative price discriminant: concessions.

Why not charge more for certain movies? For example, Woody Allen's loyal fan base is largely older Jews: i.e., highly affluent. He could probably make more revenue charging $20 per ticket.

On the other hand, a lot of other art house film makers aim at a younger market that's well educated but not consistently affluent: grad students, people who work for NGOs, those kind of folks, who might find $20 tickets steep.

In general, the current movie theatre business model is working surprisingly well after 100 years and countless new technologies. It's not terribly broken, so why fix it?

Theaters and not the studios set ticket prices. Where they negotiate is over how to split the box office take. The chain offering the studio the best terms wins the right to screen a given flick.

The distributor doesn't care what the movie cost the studio. If he smells a clunker he bids low. If he smells a hit, he offers a better deal. He'll hope he makes enough from his portion of the ticket revenue to cover his costs, with the concession stand accounting for his profits.

The box office split changes in the theater's favor after a certain number of weeks and after the movie moves to second-run venues. Distributors usually agree to wait two weeks before dropping a clunker.

Michael Bay's made some of the worst flops ever and some big hits. All were expensive. The last thing the studio/theater want is a $25 ticket for his Pearl Harbor (expensive flop) on the Friday night it opens. By Saturday night word-of-mouth will guarantee not a single ticket will sell for $25. And cutting the ticket to $10 and then $5 is the signal confirming it's a dog. Further reason not to see it.

As hard as it is to make a good movie, getting the marketing right for a good (or bad) movie is just as hard. Why throw fluctuating ticket prices into the mix as another thing the studio/theater has to get right in order to make money?

Will the typical movie-goer know that a $5 ticket means it's a brilliant flick by the next Polanski (heh) who financed its entire $25,000 cost with a credit card? Or crap the studio keeps marking down in a desperate effort to generate any revenue it can?

Bronfman's suggestion confirms his reputation as the dumbest man in Hollywood.

Hypothesis: Hollywood is running strictly on a jackpot model. They don't care that each film earn back its production cost; they're releasing a scattershot ensemble of films in which a subset might "go big".

When they release your $2M indie movie, they don't want it to have a 50% chance of grossing $3M. They want it to have a 5% chance of grossing $50M. Since they don't know which film is going to swing this way, they can't price them all low---then they'd miss out on revenue on whichever one hits the audience jackpot.

Actual economists---are there situations where this is the ideal/rational/profit-maximizing way for studios to behave?

That $12 is buying the privelege of the theater seat - not the privelege of watching the movie per se and is priced to generate volume by filling all seats - and also helps discourage the sort of person who if film seating were priced upon film production costs, buys a cheper ticket for the $10m movie because he's a bargain hunter, who then will be taking up valuable real estate while being less likely to buy popcorn and snacks which is ever so important to venue owners. Restaurants push moderately profitable entrees and set meals to gain the privelege of pushing higher profit appetizers, drinks, and deserts. Same concept - push moderately profitable seating to push profitable snackies.

DVD marketing is diffrent - it's more like book publishing economics - books of the same format adhere to like pricing structures within a dollar or two depending on the store. Newer books at full retail, older ones on sale.

Vehical Driver is absolutely right, you are paying for a service, not a product. The key question then is why is there not more variety and competition in the market for the service? You should not see prices different for different movies but for different theaters. Yes, there is some difference now between first run and discount theaters, but there should be much more variety than we see now. There is a little bit of this now with first run movies and IMAX theaters but there should be much more, with tiers or quality for the service, the screen, the sound system, the food.

I'm a netflix patron. I haven't stepped in a movie theater in over a year. I love the movies but the prices are outrageous (this economy has been brutal for me) and I'm tired of other patrons talking on their cell phones or texting while I'm trying to enjoy the show.

I think the simple reason that prices can't be different for different movies is good old fashioned Hollywood greed.

But really, why can't a movie be more like an airplane flight? The flight takes you to the same place. Yet people on the flight have paid wildly different prices for seats (even if they're all flying in economy class).

As far as paying less for a movie a few weeks after it comes out, my town has something we call the "dollar theater" (about $7 now). The seats are crappy, but you can see a movie that's been out for a few weeks a lot cheaper than at the multiplex.

There used to be (and still are a few) 'second run" movie houses that would show both old movies and obscure new movies very cheaply (in the 1980's I used to go to one in Pasadena that proudly charged $ 1 for all shows). This was, of course, based on the circulation of film reels (the reals would go to the second run theaters after they were done at the more expensive first run theaters). Now, despite the efforts to move to digital distribution, film reels still circulate, but the tier system is largely gone. I suspect that the habits of customers have changed - I know that when I take my family to the movies, it is always for a major film we want to see badly - otherwise, why not wait for the DVD ? I also know that I don't hear much complaint about the price of tickets, but a LOT about the price of concessions.

As the Internet and digital production continue to upend this Industry, I think that there will be more films made, for less budget, and there will have to be changes in the theater business. I suspect we will see more "niche" theaters - say, ones intended for adult fare (not porn) that serve alcohol, ones intended for children, etc.

I think it's funny that, on a blog called "Marginal Revolution," no one has used the word "marginal" to respond to this post yet.

But Billy and Vehical Driver are onto the right answer, despite not using the key word. All the up-front costs of producing a movie are fixed -- and sunk -- costs. What's relevant to the theater is the marginal cost, and that's approximately the same for both low-budget and big-budget movies.

I say "approximately" because things get complicated when auditoriums reach capacity, or have the potential to do so. The marginal cost function is discontinuous at that point, since you have to devote another auditorium to the movie to sell another ticket. Discontinuities are a pain in the ass, analytically speaking.

There are two main markets here - one between the studios and the movie theatres - and one between the movie theatres and the customers. Movie-goers should be willing to pay more to see better (whatever that means) movies. To the degree that movie theatres can get more people to come see a movie and charge each of them more they should be willing to pay more to get it. If there is a correlation between better and more expensive to produce then you should see higher ticket prices for more expensive to produce movies.

@ Agnostic - but reviews mean that people should have a good idea which ones might be better, plus they can go by whether their favorite actors/directors etc. are involved.

We do see different prices for concerts BTW.

"I am an independent film producer and I make films that typically cost somewhere between $5M and $10M. But when I make, say, an $8M film it has to compete at the same price level as the studios' $80M or $100M film. It costs the consumer the same $12 at the multiplex (and whatever it costs to rent a DVD from Blockbuster these days) for either film. There is no price advantage to the consumer for choosing to see a less expensive film. This naturally makes it terribly difficult for smaller films to find an audience. I find this quite fascinating and I can't readily think of another industry like it. "

I can think of many industries like this--specifically commodity industries. Regardless of what it costs for a company to produce its natural gas, for example, they can only sell it for the market price.

Obviously movies aren't commodities,and exist in a state of monopolistic competition (each product is unique). So the question is, why are they treated by the market as commodities and all priced at exactly the same price?

They did it, yet!

During the '20s and the Depression: there were 3 kind of movies, from the cheaper to the most expensive production, and the ticket cost was related to these three categories.
It seems it helped the industry during the crisis.
I don't remember the details, but I'm sure a movie expert remembers it. :)

Second-run theaters offer films that have been out for a while to be seen at a discount. The nearest second-run theater by me is showing films such as The Hangover, Orphan, G.I Joe, Up, Star Trek and Transformers among a few others. Compared to the $7-9 bucks I pay at the other theaters, the second-run offers tickets from about $3-5. Pretty sweet deal. My local indie-theater has pretty decent prices from around $5-8, and if I want to see something in IMAX or 3D or IMAX 3D a ticket costs around $12-15. Two competing multiplexes in my town have different prices for different showings. My school's club-run theater has some second-run features as well as older films (saw Days of Heaven a few weeks ago) and their tickets only cost $2, although that theater pretty much only caters to the cinephile crowd, which keeps me happy at least.

I don't think changing the prices for inexpensive films and blockbusters would do any good, because we do judge a product's worth by its price. Still, some theaters are just cheaper than others.

It's an out of touch town. My view is that those who make up the industry believe in the image of America they've created all these years regardless of what the rest of the country is truely like. There are also political factors going on involving small groups of very powerful people. As an actress I can only hope for a backswing. I look favorably on the gradual production exodus from Hollywood and independant-minded artists like Perry to bring change. It would make life as prudish actress much easier!

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