The current article aims to highlight the critical aspects of the business of film companies (production, distribution and exhibition). After reading this article, an investor would understand the factors that impact the business of film companies and the characteristics that differentiate a fundamentally strong film company from a weak one.
Types of companies in the film business
The film industry broadly involves making films for release to a worldwide audience. Indian film industry derives its revenue typically from:
- theatres in India (60%),
- overseas theatres (14%),
- satellite rights i.e. direct to home (DTH) television channels (12%),
- digital/OTT channels like Netflix, Amazon Prime, Disney Hotstar, Zee5 etc. (10%) and
- advertisements of products embedded in the movie stories (4%)
Rating Methodology – Media (Film Production, Distribution and Exhibition) by ICRA, January 2022, page 1:
Prior to the pandemic, of the total industry revenues, ~60% was contributed by domestic theatricals, ~14% by overseas theatricals, ~12% by satellite rights, 10% by digital/OTT rights and ~4% by in- cinema advertising.
The value chain of film companies has production, distribution, systems integrating companies and exhibitions.
1) Film Producers:
Film producers make films/produce content for public viewing. They get their revenue from selling movie distribution rights in India and overseas theatres, satellite TV (DTH), OTT, music rights, advertisements in the movie story and film merchandise (t-shirts, accessories etc.).
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revenue profile of film producers primarily comprises the monetisation of content through the sale of music rights, domestic and international theatrical distribution, satellite rights and new media distribution avenues such as digital and OTT rights, in-film advertisement and merchandising.
The fees of actors (star cast) are the biggest cost for film producers.
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For a film producer, the cost structure varies according to the budget and star cast, wherein the fees of the star cast form a major component of a film’s budget for most large productions.
2) Film Distributors:
In the industry value chain, distributors link film producers and exhibitors (theatres). They acquire distribution rights from producers and then release movies in theatres in their area. It is a distributor’s job to take the print of a movie from the producer and make multiple copies to supply to theatres.
Distributors may act as commission agents where they receive money from theatre owners and then pass on a share of it to film producers after taking their cut.
The major cost for film distributors is the revenue share to be distributed to film producers and the cost of replicating the movie prints.
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film distributors, in addition to…share of box-office collections to be upstreamed to the film producer, their major cost is the cost of replicating the prints.
Before digitization, the cost of analogue movie prints was about ₹50,000/- per print. Due to high costs, distributors used to make limited prints and first provide them to theatres in tier 1 cities. Only when the movie was out of theatres in tier 1 cities, the prints were sent to theatres in tier 2 & 3 cities.
However, with digitization, the cost of digital movie prints is about ₹20,000/- per print. As a result, now the movies are usually simultaneously released in a larger number of cities/theatres.
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Thanks to digitisation, the cost of replicating a print has reduced to ~Rs. 20,000 from ~Rs. 50,000 in case of analogue print replication. This enables a film distributor to simultaneously release the film in a large number of screens, unlike earlier when theatres in tier II and III cities would receive prints only after screenings in the tier I cities.
Also read: Credit Rating Reports: A Complete Guide for Stock Investors
3) System Integrators:
With the penetration of digitization in film distribution, a new class of players have emerged who provide digital infrastructure to film distributors and exhibitors. It is their job to digitize the movie prints, convert them into hard disks or directly transmit them over satellite to exhibitors/movie theatres for screening.
Apart from these activities, system integrators also provide the hardware necessary for movie screening like satellite receivers, servers, projectors etc., to the theatres.
The main sources of income for system integrators are equipment rentals from theatres, fees for replicating movie prints from distributors, advertisement income, fees for digitization of analogue prints etc.
Rating Methodology for Entities in the Film Industry (Production, Distribution and Exhibition) by ICRA, June 2017, page 3:
revenue model of digital cinema integrators comprises rentals from exhibitors, virtual print fee from distributors, advertisement income (which is shared with the exhibitors in most cases) and digitisation income.
4) Film Exhibitors (Movie Theatres):
Movie theatres are the box office, the link facing the consumer. Their major sources of revenue are ticket sales (55%), food & beverages (F&B, 25%), advertisements before the movie and in the interval (10%) etc.
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film exhibition company, the key revenue sources are ticket sales, which accounts for around 55-56% of the overall revenues, followed by food and beverages at 25-27%, with in-cinema constituting 10-12% and other revenues comprising the balance.
Major costs of movie exhibitors are the sharing of ticket revenue with film distributors and lease rentals for the movie theatre premises.
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film exhibitors, their major cost is distributor expenses, i.e., sharing revenues from ticket sales with the distributors. The other major cost for film exhibitors is lease rentals
Movie theatres usually follow a formula for sharing ticket revenue with distributors. The share of movie theatres in the revenue is usually highest in the first week, which thereafter declines in each passing week.
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After understanding the value chain of the film industry, let us now see the major factors affecting the business of these companies.
Key factors influencing the business of film companies
1) Unpredictability of box-office performance of movies and therefore profitability of film companies:
In the film industry, the profitability of each company, be it film producers, distributors, system integrators, or cinema halls; depends on how a movie will perform at the box office i.e. whether viewers will like it and come to theatres to watch it.
When viewers like any movie (a hit), then high ticket, F&B and advertisement sales lift the profitability of cinema owners and in turn, generate good revenue for distributors and producers.
However, the response of viewers is highly unpredictable and no content creator has been able to master it.
At times, films with a big star cast do very well. On the other hand, many movies with big star casts fail. Sometimes, films with a strong story do well whereas, at times, movies with good plot fail to entertain the viewers. Some scriptwriters and directors are able to produce a few good movies before they produce some of the biggest flops.
Therefore, despite any producer, director, distributor or cinema owner being in the industry for a long time, s/he is still not certain how the next movie will perform.
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key risk in the film industry is the performance of the films at the box office, which is highly dependent on viewer preferences, implying that the producers, distributors and exhibitors have lesser control over it
This unpredictability of viewers’ response is the hallmark of the film industry and in turn, makes the profit margins of film companies highly volatile.
Key Credit Factors for the Media and Entertainment Industry by Standard & Poor’s, December 2013, page 6:
Film and TV programming production have inherently high volatility associated with unpredictable audience reception
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2) Capital-intensive business:
Businesses of all the entities involved in the film industry, be it producers, distributors, system integrators and exhibitors are very capital intensive.
Film producers have to continuously keep producing movies to keep a line-up of upcoming movies and create a library of movies, which can generate consistent revenue for them.
Rating Methodology – Media (Film Production, Distribution and Exhibition) by ICRA, January 2022, page 8:
Film production is a capital-intensive business, requiring consistent investments to build a strong content slate and library
Key Credit Factors for the Media and Entertainment Industry by Standard & Poor’s, December 2013, page 8:
Pure feature filmmakers are exposed to high upfront investments and low revenue predictability
Film distributors have to commit a large amount of funds when they procure movie rights by offering a minimum guarantee to the producers or by outrightly buying its rights. In addition, they have to invest money in replicating movie prints, which is an expensive activity. Moreover, they have to focus on expanding their reach by covering the largest possible geography to offer good propositions to film producers.
System integrators have to invest in equipment for movie digitization, print replication, and content upstreaming, and buy satellite bandwidth for streaming, receivers, servers and projectors to be installed at cinemas.
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capital investments remain high for system integrators, with returns spread over a long period of time.
In addition, continuous investment is required to update equipment due to a rapid change in technology.
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While business scalability of system integrators remains restricted to the growth in the screens and theatres…they also remain vulnerable to changes in technology, their applications and acceptance.
Constructing and maintaining movie theatres is highly capital intensive as the owner has to spend a significant amount of money on the fixtures, equipment and interior decoration. s/he has to ensure that the cinema has all the latest technology in terms of movie screening, sound and seating comfort so that the theatre can offer a great overall experience to the viewers. In addition, a cinema owner has to ensure that its location is attractive to viewers, which increases its real estate/leasing cost.
Key Credit Factors for the Media and Entertainment Industry by Standard & Poor’s, December 2013, page 8:
An assessment of “adequate” may result from: Modern theater amenities (stadium seating, IMAX theaters, etc.); 4K digital projection; Good locations relative to local traffic
An exhibitor has to invest heavily in the property because other than providing a great overall movie-watching experience, they do not have any scope for differentiating their offering versus other cinemas in the vicinity. If they do not invest extensively in enhancing movie-goers’ comfort, then they end up facing strong price-based competition from competitors.
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Film exhibition tends to be commoditised with relatively lesser scope for differentiation. However, the exhibitors compete on ticket prices, seating comfort, food and beverage options and the overall movie watching experience.
Moreover, to establish and grow their brand and network, cinema exhibitors have to continuously invest large amounts of money to establish or acquire more screens.
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Film exhibition also entails high capital investments towards growing the cinema network geographically to ensure a healthy market share.
Nevertheless, despite being fixed-capital intensive, the business of movie exhibitions is low on working-capital requirements because cinemagoers pay money in advance for watching a film.
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With most of the revenues from ticket sales and food and beverage being collected in advance or on the spot, the working capital requirements for film exhibitors, however, remain low.
Also read: Operating Performance Analysis: A Simple & Complete Guide
3) The film industry is highly fragmented with intense competition:
Each segment of the Indian film industry, be it production, distribution or exhibition, is highly fragmented. There are numerous region-specific players producers and distributors, both individuals and corporates, focusing on different languages and genres of movies.
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The diverse nature of the film business has resulted in a highly fragmented industry structure, marked by a large number of film producers (individual as well as production houses) and several small (local) and big (national) film distributors.
Moreover, with good dubbing technology, now, even regional movies have started attracting viewers across different regions increasing the competition further.
In the exhibition business, there are large corporate multiplexes as well as numerous single-screen theatres in the unorganized segment creating intense competition for attracting movie-watchers.
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The Indian film exhibition industry is largely fragmented with many unorganised players operating single screen theatres and a few large multiplex chains, resulting in intense competition.
Cinema owners increasingly face intense competition from alternate channels like DTH and OTT (Netflix, Amazon Prime, Disney Hotstar etc.). One factor, which has contributed to the competition is the release of movies on these platforms within 4-8 weeks of the theatrical debut of the movie.
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emerging challenges/threats from alternative distribution platforms like direct-to-home (DTH), OTT platforms and satellite television, with the trend of telecasting movies on television/ DTH /OTT platforms within weeks of theatrical releases.
Release of movies on OTT/DTH within a few weeks as well as a high number of film releases has drastically shortened the theatrical life of any movie as now, we no longer see movies making various jubilees like silver, golden, diamond and platinum of long continuous screening in theatres for multiple weeks.
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The increase in the number of film releases every week and resultant reducing shelf life in theatres has resulted in increased competition among the film exhibitors.
Moreover, in the current times of high internet penetration when the majority of film viewers have access to DTH and OTT apps, movie producers tend to bypass cinema owners and release movies directly on these platforms to save revenue sharing with distributors and cinema owners. This further reduces the bargaining power of cinema theatres.
Key Credit Factors for the Media and Entertainment Industry by Standard & Poor’s, December 2013, page 13:
We do not assess motion picture exhibitors as “strong” or ” strong/adequate” because of production studios’ incentives and business initiatives to distribute directly to the consumer via digital platforms, and exhibitors’ inflexible cost structures.
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4) Large companies enjoy a lot of competitive advantages in the film industry:
Film producers, distributors as well as exhibitors that have a large scale of operations enjoy a strong competitive position.
Large film producers provide better, big-budget movies to established stars. In addition, they enjoy better bargaining power over star cast, distributors, DTH and OTT players. As a result, they can access better talent, create good content and monetize it well.
In addition, large producers have the financial flexibility to continuously make movies one after another and reduce the volatility of earnings and profits, which otherwise affects the entire film industry.
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large media conglomerates…not only enjoy higher bargaining power but are also able to monetise content investment across platforms compared to small-scale producers, thereby reducing the inherent volatility in the films business…better positioned to make incremental investments in attractive content
Similarly, large distributors offer a very good proposition to film producers. When dealing with large distributors, a film producer needs to deal with fewer counterparties. In addition, large distributors have the financial strength to pay for and release big-budget movies across geographies.
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With substantial scale of operations, the entity is better positioned to make incremental investments in big budget movies, thereby enhancing its competitive position…An entity with a healthy global brand recognition enjoys higher bargaining power with film producers, posing entry barriers for new players in the industry.
In addition, global production houses (e.g. Hollywood) prefer to deal with large domestic distributors, which further increases their competitive position. They can hire and retain the best professionals as well.
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An entity with a strong market position, aided by tie-ups, strategic joint ventures and licence agreements with global brands and studios, enjoys higher bargaining power along the value chain and is better positioned to acquire and retain the best talent…large scale of operations and substantial level of vertical integration enhances the competitive position of the entity.
In the case of movie exhibitors (cinema theatres), large multiplex players with many screens spread across multiple geographies have a higher bargaining power over film distributors. In addition, such multiplexes, due to their financial strength are able to invest in better screening & sound technology, more comfortable seating, food & beverages etc. It improves viewers’ overall experience and in turn, they can charge a premium price on tickets and earn a higher share of customers’ spending.
No wonder that multiplexes earn a higher revenue per screen than their unorganized competitors.
Rating Methodology for Entities in the Film Industry (Production, Distribution and Exhibition) by ICRA, July 2019, page 1:
While multiplexes accounted for 31% of the total screens, they drove around 55% of the domestic box-office collections in CY2018.
Additionally, large entities in the film industry enjoy economies of scale benefits as their administrative and fixed costs are spread over a large business. This helps in the improvement of their margins as well as large scale of business with continuous movie production and screening also reduces volatility in earnings.
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A large revenue base, an indicator of the scale of operations, also leads to economies of scale in terms of cost efficiencies in the production and administrative functions…impact of scale is also reflected in the stability in its operating profit margins.
Therefore, large integrated media houses, which have their presence in production, distribution as well as exhibition are competitively better placed than their standalone peers.
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5) Other risks faced by the film industry:
5.1) Piracy:
Piracy is one of the biggest risks faced by the film industry. It has a severe financial impact on the industry.
There have been numerous instances where pirated copies of movies have been released by piracy cartels/mafia on the same day/before the official release.
Nevertheless, with the recent penetration of digitization and direct streaming of movies to theatres via satellite has reduced the risk of piracy.
Rating Methodology – Media (Film Production, Distribution and Exhibition) by ICRA, January 2022, page 7:
…because of digitisation, making it affordable for a distributor to simultaneously release a greater number of prints, while preventing piracy.
5.2) Regulatory risk:
The film industry impacts the masses both in terms of the quality of content as well as their physical safety when a large group of people sit in a hall for movie watching. Therefore, govt. regulators stipulate numerous approvals and certifications for movie releases as well as screenings.
For example, film producers have to follow the guidelines of the Central Board of Film Certification (CBFC) while making and releasing films. The producers also need various approvals while shooting movies in different locations.
Cinema/theatre owners have to obtain operating licenses after meeting numerous conditions for the safety and functioning of theatres.
The requirement of these govt. approvals on the one hand act as an entry barrier for new players; however, on the other hand, these strict guidelines at times, interrupt the production, release or screening of films.
There have been numerous instances where govts. have restricted (banned) the screening of movies with controversial content, which may lead to a large financial loss to film producers.
Some state govts. also control the pricing of movie tickets e.g. Madhya Pradesh, Tamil Nadu and Kerala put taxes over and above GST. In addition, the states of Tamil Nadu and Karnataka put a cap on the ticket prices that theatres can charge.
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Madhya Pradesh, Tamil Nadu and Kerala had announced local body taxes on ticket prices in addition to the applicable GST. Additionally, a cap on ticket prices in certain states like Tamil Nadu and Karnataka
On the other hand, at times, in order to promote the viewing of certain films, state govts. declare them tax-free in their respective states.
Also read: How to do Financial Analysis of a Company
5.3) Seasonality risk:
Movie watching faces certain patterns like the turnout of viewers is significantly higher on weekends than on weekdays. In addition, periods of school examinations also have significantly lower turnout of viewers.
Rating Methodology – Media (Film Production, Distribution and Exhibition) by ICRA, January 2022, page 3:
It is predominantly a weekend business, with weekdays witnessing significantly lower occupancies at movie theatres. It also remains exposed to seasonality risks with the occupancy levels declining during periods of school examinations
Apart from the above risks, the film industry is also exposed to event risks like health scares (e.g. Covid pandemic), terrorist attacks and other natural calamities like earthquakes and floods etc.
6) Diversified operations add to the competitive advantage of film companies:
Film companies with diversified operations benefit from a lower impact of volatility of box-office performance of movies as well as other risks like seasonality, event risk etc.
As film producers and distributors are not able to predict, which movie will do well at the box office; therefore, those entities that produce a diversified mix of films across different budgets (big star cast as well as good-content driven small star cast films), different languages (regional as well as national), genre (action, comedy, suspense, drama) etc. have a higher probability of a few of their films becoming hit and provide consistent revenue.
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strategies may include selecting a judicious film mix in terms of budgets or regional language movies to focusing on content-driven films rather than relying on star-driven films.
Diversification of content across genres, languages and budgets helps to partly mitigate the risk of losses due to poor box-office performance of some of the films
Film producers have also started to tweak/diversify their risk by offering big stars a revenue share in the film instead of high fixed payments.
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Increasingly, the revenue share with the star cast, as against a flat fee, has also become prevalent, especially for high budget movies, as a step towards de-risking partially from the performance of the film at the box office.
Similarly, film distributors also follow multiple strategies of revenue sharing with film producers to reduce their risk like a flat revenue share, a minimum guarantee of revenue to the producer and then a fixed revenue share and an outright purchase of theatre rights from the producer.
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Film distributors generally operate on two business models—the revenue share model and the minimum guarantee or outright purchase model.
Fixed percentage revenue share with producers has the least risk for the distributor whereas outright purchase of rights has the most risk and also the most profit potential for the distributor.
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P5
The revenue share model involves less downside risk where a fixed percentage of revenues (box-office collections) is retained by the distributor as commission…minimum guarantee or outright purchase of rights by the distributor, a significant amount of risk of the film’s performance is borne by the distributor.
Distributors diversify their operations by acquiring other rights like satellite, digital, media and music rights of the film in addition to theatrical rights, which reduces the risk of losses if the film flops at box office.
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expose the distributor to box-office performance risks, although it is partially offset by the sale of other rights (including, among others, satellite rights and digital rights) when the distributor owns the entire distribution rights for a film.
Cinema owners (exhibitors) tend to diversify their operations by expanding in different geographies to reduce the risk of movies of any one language/genre failing in a region or any disruptive event in any region. Geographically spread-out cinema halls also reduce seasonality risk because different regions in India have school examinations and holidays in different periods.
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geographical spread of the film exhibitor, which in turn drives occupancies…Diversified screen presence protects the company from region-specific events such as natural calamities or political disturbances
Therefore, film companies with diversified operations may benefit from a reduced volatility of earnings and profit as compared to their undiversified standalone peers.
7) Ratios:
Exhibitors/cinema-owning companies have inflexible high fixed costs as they have to construct and run a full multiplex irrespective of the number of cinema viewers watching the movie at any time. The screening equipment, air-conditioning, minimum staff etc. is required to present and work whether the theatre is houseful or has only a handful of viewers.
Therefore, cinema owners have a very high operating leverage where an increase in occupancy levels improves profit margins significantly as most of the costs are anyway being incurred.
As a result, occupancy level is the most important ratio for cinema owners.
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With its high operating leverage, the revenue profile of film exhibitors remains highly vulnerable to the occupancy levels of cinema properties
Business of each of the entities involved in the film industry including producers, distributors, system integrators and cinema owners is highly capital intensive. Therefore, ratios for assessing debt/leverage are critical for assessing the financial strength of film companies. Companies with high debt face the risk of going bankrupt in the down cycle.
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heavy reliance on debt financing, are likely to be more vulnerable to cyclical downturns than entities who employ conservative financial leverage in their business
Also read: How to do Financial Analysis of a Company
Summary
One of the biggest hallmarks of the film industry is the uncertainty of films’ performance at the box office. No one formula works every time and as a result, films of even established actors, directors and production houses flop. Therefore, the revenue and profit performance of every entity involved in the film business, be it producers, distributors, system integrators or exhibitors (cinema owners) is very volatile.
The business is highly capital intensive, requiring large investments in creating films, distributing them or creating luxurious cinema halls to give a good experience to the viewers. However, despite large investments, players face intense competition as the industry is highly fragmented with a large number of unorganised players working in content creation, production, distribution and exhibition providing strong competition.
Nevertheless, large players enjoy a lot of competitive advantages be it in film production, distribution or exhibition. Large film producers are able to create multiple movies across genres and budgets with good star casts in the expectation that some of them will become hits.
Similarly, large distributors are able to buy rights for big-budget films both from Indian and global media houses and are able to simultaneously release movies over a large part of the market. Established film producers prefer to deal with a few large distributors instead of multiple small regional distributors.
Large cinema owners (multiplexes) are able to build a good brand and geographical reach and invest in giving a great overall experience to the viewers. As a result, they are able to charge premium pricing and earn a higher share of film exhibition revenue in the industry.
Large players also mitigate the impact of risks like a few films flopping at the box office by making a diverse range of movies, mitigating seasonal and event risks with presence in diverse regions with different examination and holiday schedules etc. Large players also have the financial strength to produce multiple movies one after another, hire good star cast and professional talent, enjoy economies of scale with large operations etc.
Film companies face a high regulatory risk with multiple certifications and approvals required to start and run their operations.
Large players tend to control all risks and volatility of financial performance better than their smaller standalone peers.
An investor should always keep in mind these multiple aspects of film companies to understand their business position.
- Unpredictability of box-office performance of movies
- high volatility in revenue and profitability
- Capital-intensive nature of business
- A highly fragmented industry with intense competition
- Large size with economies of scale brings in a competitive advantage
- A strong brand and market position is an advantage
- Diversification of geographical presence, movie segments, and target audience brings strength to a film company’s business model
- Film companies face significant regulatory, seasonality and funding risk
- Investors should focus on the debt levels of film companies with special attention to the occupancy levels of cinema owners.
We believe that if an investor analyses any film company by keeping the above factors in mind, then she would be able to assess its business properly.
Regards,
Dr Vijay Malik
P.S.
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Disclaimer
Registration status with SEBI:
I am registered with SEBI as a research analyst.
Details of financial interest in the Subject Company:
I do not own stocks of the companies mentioned above in my portfolio at the date of writing this article.
