The COVID-19 pandemic caused seismic changes in the entertainment industry as movie theaters shuttered and productions were forced to go on hiatus. With so many consumers quarantined, the industry witnessed a remarkable level of adoption of streaming at home as anticipated new subscriptions in 2021 were pulled forward into 2020. More than that, the pandemic also shattered the long-standing distribution paradigm. In this blog, I’ll explore the implications of new hybrid film release strategy approaches by movie studios and how forecasting film ultimates has become more complex in the current environment. I’ll also cover Average Revenue Per User (ARPU) as applied to streaming services – and how this key performance indicator is critical for finance leaders to measure and forecast accurately.
In Film Release Strategy News, Flexible Windowing is Here to Stay
Stopping and restarting a major marketing effort as a movie progresses from a long theatrical window to the home entertainment window is a terribly inefficient use of capital. Motivated by a desire to piggyback on the awareness resulting from a movie’s theatrical marketing campaign, studios attempted several times pre-pandemic to shorten the theatrical window, only to face intense pushback from exhibitors.
As it happened, COVID-era lockdowns and theater closures emboldened Hollywood executives to experiment with new approaches to film release strategy. One such experiment, premium video-on-demand (PVOD), has become the hottest industry craze. Studios have shattered the traditional 90-day exclusive theatrical window by offering their movies early for a premium price at home. In doing so, they’ve ushered in the age of the hybrid release option, in which a film is released theatrically and on PVOD simultaneously. This “day-and-date” strategy is now firmly in the studio’s arsenal, along with a shortened exclusive theatrical window such as 45, 31 or even 17 days.
The distribution flexibility that the day-and-date affords is a matter of subjectivity. Disney CEO Bob Chapek remarked, “We’re really celebrating that flexibility…we’re trying to offer consumers more choice.” The National Association of Theater Owners had a much different take following the July 9th day-and-date release of Black Widow, calling the hybrid release a “pandemic-era artifact that should be left to history with the pandemic itself.”
Consumers have benefitted the most from this change: they have access to more content on more platforms than ever before. This change has also been good for studios, which have been desirous of greater distribution flexibility for many years. It took an exogenous shock on the scale of a global pandemic to overcome the inertia, and there is no turning back.
This new age of hybrid releases as a part of film release strategy also means pressure will be placed on finance managers to create robust forecast models able to accommodate a wider range of potential financial outcomes. One size does not fit all in the new world of film distribution.
Is PVOD Revenue Really a Net Gain?
Even before COVID-19, studios distributed blockbusters that sell the most tickets and popcorn differently than niche films that win Oscars and festival awards. But now, especially within the tentpole category, maximum flexibility will dominate the consciousness of Hollywood C-Suite executives.
The marketing efficiency gained from a compressed theatrical window is not in question, nor is the fact that PVOD margins are terrific – a fact often overlooked by theater owners that emphasize total revenue when criticizing hybrid releases.
However, what remains inconclusive is the extent to which hybrid releases will cannibalize theatrical sales. It’s also unclear if PVOD will provide a consistently additive revenue stream above what would have been realized from a more traditional VOD window after accounting for lost grosses at the box office. Revenue that is merely pulled forward is not truly additive.
The (Slow) Comeback of the Cinematic Experience
Movie theaters are reopening, and several analysts put the theatrical business back to normalized levels of capacity and revenue eventually – though perhaps not for a few years. The shared experience of being in a theater with other people is not something that advancements in technology can fully replicate at home. There is good reason to expect a rebound in movie exhibition, although the relationship with content creators has been permanently altered.
Universal Pictures recently struck multi-year deals with exhibitors to dramatically shorten the exclusive theatrical window. In exchange, they’re offering the theater chains a cut of the new digital rental revenues. The agreements allow the studio to release a movie on PVOD platforms such as iTunes or Amazon Prime in either 17 or 31 days post-theatrical release, depending on whether the movie hits a $50-million opening box office threshold.
Disney is likewise emphasizing optimal flexibility, with movies such as Black Widow and Jungle Cruise going day-and-date, while other planned releases such as Free Guy and Shang-Chi going with a shortened 45-day window. Warner Bros. isn’t eliminating all exclusive theatrical releases either but will pursue flexible windowing that will be equally difficult to predict from slate to slate. In July, WarnerMedia CEO Jason Kilar stated that the company will produce 10 movies next year exclusively for its streaming service HBO Max, while reserving the right to release tentpoles at the local multiplex. It’s fair to say that exclusive theatrical windows are not going extinct. Some movies will still have an exclusive theatrical run, but not all. And for those that do, the window will be considerably shortened.
Flexible Wi(n)dow Results in the First Breach of Contract Lawsuit
Another consequence of day-and-date releases and condensed windows is the way A-list actor compensation is likely to be structured. On July 29th, it was reported that actress Scarlett Johansson is suing Disney for breach of contract. The lawsuit claims the studio knowingly violated Ms. Johansson’s Black Widow contract by shifting profits out of the theatrical window and into Disney+ PVOD, while leaving key partners (such as talent) out of the new financial equation. In this case, the hybrid film release strategy may have cost Ms. Johansson tens of millions of dollars in backend compensation tied to box office ticket sales.
Regardless of the legal outcome, we should anticipate the highly public nature of this dispute to impact contract negotiations going forward, and in turn, the structure of participations and residuals for high profile talent. In the context of calculating talent bonuses, finance departments will have a key role to play in determining the right metrics to gauge a film’s success on streaming, as simply pulling up box office receipts on Monday morning is no longer sufficient.
Ultimates Forecasting in the New Distribution Paradigm
Finance managers responsible for forecasting movie performance typically run several box office scenarios and utilize comparables analysis to derive long-range revenue and net contribution conversions across the home entertainment windows. The value of all future cash flows over a 7- to 10-year timeframe is referred to as a film “ultimate.” About two weeks prior to domestic theatrical release, finance managers update their expectations for box office returns and the corresponding film ultimates in the various transactional and licensing markets – with particular emphasis on how revised baseline forecasts compare to what was originally planned.
The distribution flexibility studios now enjoy will allow for greater revenue optimization within the film slate. And yet, finance departments should be prepared for higher window-by-window variances in cases where the actual release strategy differs from what was assumed during the planning period.
Learn more about Ultimates in these related posts:
- “Entertainment Finance: Perfecting Film Ultimates”
- “Common Mistakes When Creating a Film Ultimate”
- “Adjusting Film Ultimates in Response to COVID-19 Impacts”
How Comparable are Comparables?
Another forecasting challenge will be finding good, meaningful comparables (“comps”). Finance managers build ultimates by leveraging historical comps, which are catalog titles in the same franchise or recent titles in the same genre.
Although still valuable as model inputs, comparable titles from only a couple years ago will reflect results from renting and selling movies in a strikingly different distribution landscape than what we see today.
Entertainment finance professionals are accustomed to updating methodologies as technology changes the content delivery mechanism. For example, over the past decade, we have seen a rapid decline in DVD/BluRay revenues as a share of the overall economic pie, while electronic sell through (also referred to as “electronic home video”) and VOD have grown significantly. Ultimates needed to account for this fundamental shift from physical to digital and will once again need to be refined to accommodate the current trend toward flexible windowing.
Assumptions, They Are A-Changin’
The underlying assumptions driving ultimates (such as decay curves) are generally only adjusted once per year, at the end of the year. Considering the dramatic disruption to windowing over the past 18 months – the effects of which haven’t fully settled – these assumptions may need to be revisited more frequently.
In terms of decays, an average film would traditionally decay about 50% per week in the standard theatrical window of old. But that’s not the level we are seeing so far on hybrid releases. Marvel’s Black Widow is a good case study. Despite opening weekend domestic box office of $80 million, week-two grosses fell 68% to $26 million.
That’s a steep decline in only one week and the steepest ever for a Marvel release. It’s exacerbated by the fact that viewers could simultaneously stream the film on Disney+’s Premier Access for thirty dollars. This begets a host of questions:
- Would those PVOD viewers have still been there in a more traditional post-theatrical VOD window while also showing up to theaters?
- Would piracy have had less of an impact on theatrical grosses without day-and-date being a factor?
- Was the second week drop-off driven by PVOD or by the fact that audiences were simply underwhelmed by the movie?
There are no conclusive answers to these questions, but finance managers should be thinking of creative ways to use data to lead us toward clearer understanding.
Don’t Forget the Potential Impact to International Markets
It will be important for finance managers to carefully evaluate their approach in estimating content sales ultimates in international markets. As a matter of practice, finance managers model international ultimates by running regressions on domestic box office (DBO) versus international box office (IBO) for previously released comparable titles. Then, for any upcoming film about to be released commercially, they use this historical relationship to estimate the corresponding IBO for every given DBO scenario in an expected range.
The estimated IBOs are converted to international revenue and profit ultimates across all release windows such as DVD/BluRay, electronic home video, VOD, Pay TV, and Free TV. Finance managers build these pre-release ultimates on a by-territory basis, consolidate the results into a total international view and then combine them with the domestic model to gain a global perspective. This approach remains sound. However, close attention should be paid to how shifting domestic release strategies such as day-and-date theatrical with PVOD will impact IBO projections – and consequently, all downstream international financial returns.
ARPU & Why It Matters
While the industry press likes to focus on which streaming service is ahead or behind expectations on subscriber count, the metric that should be given more attention – and the one closely followed by Wall Street – is Average Revenue per User (ARPU).
Investors care not only about the amount of revenue generated, but the quality of that revenue. That’s where ARPU comes into play. The number of subscribers is certainly an important measure of consumer demand for a streamer’s product offering, and it makes for great headlines. However, the real winners in the “streaming wars” will be those that best monetize their subscribers by converting them into higher levels of revenue received on a per-user basis.
The ARPU metric is not unique to entertainment. It’s widely used in companies that rely on monthly recurring revenue from subscriptions, whether from selling memberships in a streaming platform or from selling software licenses. The basic idea is the same:
ARPU = Total Monthly Subscription Revenue / Average Number of Users of the Service
Beginning MRR in Current Month = Ending Revenue in Prior Month + Revenue from Projected New Subscribers and Upgrades to Higher Price Tiers – Revenue from Cancels and Downgrades to Lower Price Tiers
Therefore, the key to boosting ARPU is to increase revenue growth faster than user growth, either by raising the standard price point over time (as players like Netflix and Disney have done) or by encouraging customers to pay more for premium offerings such as bundled content, Ultra HD availability, ad-free experiences and the ability to stream to multiple devices at the same time. (That’s the nice thing about math: it gives some very clear guidelines.)
Subscriber Growth & ARPU: An Inherent Trade-off?
Not all subscriber growth generates the same financial returns. ARPU can take a hit if a streaming service hits saturation in the domestic market and must look elsewhere to keep up with the rate of subscriber growth that Wall Street expects. The total addressable market is massive. However, if a significant percentage of new subscribers comes from less lucrative territories where rollout prices are much lower, this will put downward pressure on ARPU. As was revealed in Disney’s recent quarterly results, the launch of Disney+ Hotstar in India lowered Disney’s overall ARPU. Raw subscription growth in lower priced regions will lower ARPU over time if prices are not raised elsewhere to compensate. The deadly combination that a streaming platform does not want to see is both slowing subscriber growth and declining ARPU.
Netflix’s ARPU dominance over Disney+ has been a hot topic of late, and the numbers (sourced from company reports) tell the story:
- Netflix’s domestic ARPU sits at $14.54 per month.
- Disney+’s ARPU excluding Hotstar is $5.61.
- Netflix Global ARPU increased 8% in its most recent quarter.
- Disney+ Global ARPU declined 29% to $3.99 in its most recent quarter.
Comparing paid membership counts, Netflix is king with 209 million subscribers, followed by Disney with roughly half that amount at 104 million. But Netflix had a 12-year head start. In the next handful of years, it’s not unreasonable to expect Disney+ to surpass Netflix in global paid membership count – but still fall far short in revenue due to ARPU. Disney+ isn’t going to catch Netflix in the ARPU game for a long time to come.
Investment in Content Boosts Customer Retention
Having the highest ARPU in all the land isn’t necessarily Disney’s main objective, however. The biggest players in the space, particularly Disney, have strong IP that allows them to continue pumping out branded films and series to boost user adds and keep existing users in the monthly recurring revenue base.
Content is king, but it’s also expensive. Where does the money come from to pay for all this new original programming? Through the higher fees charged to streaming customers. Higher fees raise ARPU, as discussed, while customer attrition (also called “churn”) is held in check by funneling the added revenue into the budgets of new, high-quality productions that satisfy the desires of paying customers.
At the end of March, Disney+ initiated its first price hike in the first 16 months of launch and reported no increase in churn. The price increase was even more pronounced in Europe, where churn actually improved because more content offerings were added to the mix. Netflix also reported churn in the most recent quarter below prior-year levels, despite U.S. price increases in its standard and premium plans, providing further evidence that growth in perceived product value can support higher pricing.
It will take years for the dust to settle on the streaming wars, and there will be winners and losers. Only those services that offer high perceived value relative to cost will survive. Finance managers will need to continually hone their forecast methodologies, test their assumptions and focus on the right performance metrics to position their companies for long-term operational success and profitability.
You can learn more about subscription modeling in our Subscription-Based Financial Model Guide.
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About the Author
Chris has 15 years of diverse finance experience across a variety of industries including entertainment, healthcare, distribution, retail, financial services, and information technology. He has held various positions in middle-market, high-growth and Fortune 500 companies. Prior to 8020, Chris held manager and senior manager finance positions at The Walt Disney Company, Focus Features (a division of NBCUniversal), Blue Cross Blue Shield Association, and SpartanNash Company. He consulted for Universal Pictures Home Entertainment and Zacks Investment Research after beginning his career as Equity Research Analyst for Piper Jaffray. Chris has a broad range of experience in financial reporting, budgeting, financial modeling, M&A transactions, contract negotiations, strategic planning, business development and post-acquisition integration. He holds a M.S. in Applied Economics and Management from Cornell University and a B.S. in Applied Economics from the University of Minnesota.
Categorized in: Entertainment, Financial Planning & Analysis