When Fox decided to make the movie Titanic, the studio called upon Paramount to put up $65 million to help finance the film in exchange for a portion of profits and movie rights. Fox covered its derriere by sharing risk for the picture through the co-financing deal — but wound up ceding $600 million of the picture’s earnings to Paramount. Co-financing is something studios have increasingly embraced since the 1990s, ostensibly to mitigate risk in one of the chanciest businesses on the planet, but recent research indicates that the practice may not be an effective risk-management tool.
Phillip Leslie, associate professor of strategic management, has studied more than 1,300 movie deals made by a major studios between 1987 and 2000 and has found that co-financed movies — those whose costs and, consequently, ownership rights and profits are shared by more than one firm — are just as risky as studios’ solo-owned movies. “The evidence flies in the face of what we’d been reading in the trade press and had heard from executives — that co-financing lowers risk when no one is sure that the movie will be a hit,” says Leslie, who recently published his paper, co-authored with Ronald Goettler of Carnegie Mellon University’s Tepper School of Business, in the Journal of Economics and Management Strategy.
“We expected to find that co-financed movies tend to have higher variance in profitability than films that are solo-owned by studios, based on the claim we repeatedly heard and read that studios choose to co-finance the relatively risky movies,” says Leslie. However, he and Goettler find that the distribution of return on investment is identical for co-financed and solo-owned studio movies. Hence, according to Leslie, “On a film-by-film basis, there is no evidence that co-financing lowers risk for studios.”
Co-financing may make sense from a risk perspective for the hugely expensive blockbusters, he says. Who, after all, would want to be stuck with a Titanic that ended up sinking? Universal, for example, wagered that The Incredible Hulk would be a smash at the box office — and consequently decided to finance production itself so as to keep all of the profits. The studio bet incorrectly, however, and suffered a loss. Had it co-financed that one, Universal would have had more in the bank to finance other hopefully more successful films. “One interpretation of our findings,” says Leslie, “is that studios are no better at deciding which films are risky projects than if they just rolled the dice.”
Co-financing may still lower the riskiness of a studio’s overall portfolio. “Say a studio has a budget of $1 billion for the year to finance movies,” Leslie explains. “Then the studio could make 10 movies each costing $100 million, say. Or it could take half ownership in 20 films each costing $100 million with the studio contributing $50 million to each project. The latter seems like a reasonable strategy for lowering the riskiness of the studio’s overall portfolio. But after return on investment is calculated, the studio could also have made 20 movies, each costing $50 million, be the sole of owner of each movie, and it could have made a higher return.”
So, since blockbusters are no more profitable than small-budget affairs and carry a lot of hassle with them, why don’t studios just make smaller films? That, perhaps, is the $64 million question, says Leslie. “In many ways, our paper raises more questions than it answers,” he acknowledges.
While the quest for profits drives many decisions in the movie industry, Leslie speculates that other factors also enter the mix. “There are complex negotiations that affect any deal having to do with stars and high-powered directors with multi-picture demands, as well as studio executives’ career concerns,” he says. “For example, it may be that an executive is more likely to say yes to a large movie with Tom Cruise than a smaller movie with an unknown star — because his or her head is less likely to roll if the Tom Cruise picture fails. There’s obviously more than just vanilla economics at play when it comes to Hollywood.”
Leslie admits that his study has limitations because it is based on U.S. box office data and generally does not take into account foreign box office sales or video revenues. Leslie also does not consider in his calculations revenues that may come from other streams associated with a given film, such as theme parks and related merchandise. Still, he stands by his results. “I would be surprised if an analysis of more complete data led to anything very different from what we have found,” he says. The bottom line, it seems, is that co-financing is not all it’s cracked up to be for movie makers.
