Film industry value chain

The revenues earned by a Hindi film are split between the three elements of the value chain - producers, distributors, and exhibitors. The ratio in which the revenues are split and the risk borne by each element in the chain is based on the nature of agreement they have entered into.

There are four models generally followed for the distribution of revenues between exhibitors and distributors:

·         Revenue share model, which is mostly followed in the case of multiplexes

·         Theatre hire model

·         Fixed hire model

·         Minimum guarantee plus royalty model

Three models are in vogue for the distribution of revenues between distributors and producers:

·         Minimum guarantee plus royalty model, which is followed in the case of 60-70 per cent of films according to CRISIL Research estimates

·         Commission model (followed in case of 20-30 per cent of films)

·         Sale of global distribution rights (followed in case of 10-15 per cent of films)

Risk Assessment across elements in the value chain     

In this section, CRISIL Research has attempted to assess the risk to the profitability of various elements across the film industry value chain in view of the changing dynamics of the industry. We have done this by analysing the performance of producers, distributors and exhibitors over the following three distinct time periods:

·         2005/2006 - which refers to the period before there was a surfeit of funds flowing into the industry.

·         January-September 2008 - referring to the period during which huge amounts of money previously raised from public markets was used in film production and distribution.

·         2009/2010 - which represents the 12-18 months after the global meltdown.

For our analysis, we have considered a Hindi film made on a budget of Rs 200 million in 2005/2006.The other main assumptions are as follows:

·         Cost of production: The cost of production has seen a steep increase over the last couple of years owing to the influx of corporate funds. CRISIL Research estimates that a film made with a budget of Rs 200 million in 2005/2006 would have required a budget of Rs 350 million to produce in 2007/2008. Going ahead, we anticipate a correction of about 20-30 per cent in production costs, largely owing to reduction in the costs of acquiring talent.

·         Distribution of prints: Films are getting a wider release due to the larger number of prints being distributed as compared to a couple of years before. This is mainly due to the advent of digital prints. A film, which released in 2005/2006 with about 450 prints, would have had a wider release with about 900 prints in January-September 2008, with about 30 per cent digital prints. We expect such a film to be released with 1,100 prints in 2009/2010 with about 40 per cent of them being digital.

·         Total minimum guarantee: The entry of a large number of organised players, replete with public funds, has resulted in a scramble for rights associated with films, which pushed up acquisition prices by 70-80 per cent since 2005/06. In the next 12-18 months, we expect a correction of 20-25 per cent in the cost of acquiring distribution rights.

·         Other revenue streams: With the easy availability of funds, the prices of ancillary rights also zoomed by about 50 per cent over 2005/2006. Looking ahead, we see a correction in the cost of such rights commensurate to the decrease in production costs, especially in cable and satellite rights, given the pressure on advertising revenues earned by television broadcasters.

Table 1: Key assumptions for the risk analysis

	Unit	2005/2006	Jan-Sept 2008	2009/2010
Total cost of production	Rs mln	200	358	285
Share of different costs	per cent
Set, daily shooting and outdoor		30	27	29
Key talent costs		35	43	35
Other production expenses		20	17	19
Publicity and others		15	13	18
Prints distributed	Nos	450	900	1,000
India - Physical		315	425	440
India - Digital		65	325	385
Overseas		70	150	175
Minimum guarantee paid by distributor	Rs mln	107	182	155
Total revenues across value chain	Rs mln	693	895	918
Net box office collections	Rs mln	564	705	779
Theatre revenues per print	Rs mln	1.3	0.8	0.8
Satellite rights	Rs mln	55	100	60
Home video rights	Rs mln	25	40	34
Music rights (physical and digital)	Rs mln	44	40	38
In-film advtg, merchandising, etc	Rs mln	5	10	7
Share of box office in total revenues	per cent	81	79	85
Source: CRISIL Research

 

Producers bear the least risk

The economics of film production has improved considerably in the last 4-5 years. With ancillary revenue streams such as home video rights, cable, satellite and music rights increasingly contributing to the producer's kitty and finance available from organised sources, production has become much more organised and producers are no longer dependent on the box office collections of a film. However, producers still have to grapple with three main risks:

·         Completion risk: Producers face the risk of not completing the film due to various factors including running out of funds, not being able to retain talent etc.

·         Time and cost overruns: Not completing the film in the scheduled time would lead to cost overruns which would negatively effect the producer's margins.

·         Changing audience preference: The risk of change in audience tastes and preferences over the course of the production of the film is inherent in film production. Distributors' perception of audience preferences also influences the acquisition price for a film.

Producers can mitigate these risks to some extent by selling global distribution rights before the release of the film. By doing so, the producers' margins are locked-in and their profitability will no longer be influenced by box-office performance. However, significant budget overruns would negatively impact margins.

The risks are higher in a minimum-guarantee deal in which the theatre rights of a film are sold when the film is nearing completion, but the rewards are higher too. The risks borne by the producer is the highest in the commission model, when the producer bears almost all the costs of taking the film to the audience.

Table 2: Trend - Film producer operating margins

	2005/2006	Jan-sept 2008	2009/2010
Minimum guarantee model	27%	11%	19%
Selling global distribution rights upfront	18%	6%	8%
Commission	16%	6%	11%
Source: CRISIL Research

CRISIL Research believes that even though production costs have shot up between 2005/2006and 2008, producers have still been able to make decent margins as acquisition costs for a distributor have also increased. Going forward too, we believe that producers would continue to enjoy healthy margins as long as they consistently make films, wherein the entire value chain makes money and keeps costs in check.  

Table 3: Film producer operating margins - Sensitivity to revenues

	Base scenario	Scenario 1	Scenario 2	Scenario 3	Scenario 4
		Revenues
	2009/2010	20%	10%	-10%	-20%
Minimum guarantee model	19%	31%	25%	11%	3%
Selling global distribution rights upfront	8%	8%	8%	8%	8%
Commission model	11%	25%	19%	1%	-12%
Source: CRISIL Research

Table 4: Film producer operating margins - Sensitivity to costs

	Base scenario	Scenario 1	Scenario 2	Scenario 3	Scenario 4
		Cost
	2009/2010	20%	10%	-10%	-20%
Minimum guarantee model	19%	1%	10%	28%	36%
Selling global distribution rights upfront	8%	-10%	-1%	17%	26%
Commission	11%	-7%	2%	19%	28%
Source: CRISIL Research

Distributors have borne the brunt of rising costs

The unscientific nature of the process, and exposure to changes in audience tastes and preferences, which can be volatile, make distribution a risky business.

The commission model is the safest model for distributors, where they play the role of a mere agent between the producers and the exhibitors and enjoy fixed margins although the absolute amount earned is still dependent on the box-office revenues.

However, most films from organised production houses are sold using the minimum guarantee model. In addition to the minimum guarantee, distributors also spend on making the prints of a film, and promoting and publicising the film, which add about 30-40 per cent to a distributor's cost. In order to break-even, a distributor has to recover all these costs.

Table 5: Trend - Film distributor operating margins

	2005/2006	Jan-Sept 2008	2009/2010
Minimum guarantee model	8%	0.3%	9%
Purchasing global distribution rights upfront	14%	5%	16%
Commission	10%	10%	10%
Source: CRISIL Research

Between 2005/2006 and 2008, acquisition costs of distribution rights soared such that they were not in line with the revenue potential of the films, thereby resulting in inadequate returns and losses for distributors in some cases. Over the next 12-18 months, CRISIL Research expects distributors' margins to improve to levels seen in 2005/2006, as acquisition costs for distribution rights are projected to decline significantly.

Table 6: Film distributor operating margins - Sensitivity to revenues

	Base scenario	Scenario 1	Scenario 2	Scenario 3	Scenario 4
		Revenues
	2009/2010	20%	10%	-10%	-20%
Minimum guarantee model	9%	16%	13%	5%	-2%
Purchasing global distribution rights upfront	16%	30%	23%	6%	-6%
Commission model	10%	10%	10%	10%	10%
Source: CRISIL Research

Table 7: Film distributor operating margins - Sensitivity to costs

	Base scenario	Scenario 1	Scenario 2	Scenario 3	Scenario 4
		Cost
	2009/2010	20%	10%	-10%	-20%
Minimum guarantee model	9%	7%	8%	10%	12%
Purchasing global distribution rights upfront	16%	12%	14%	17%	19%
Source: CRISIL Research

Paucity of quality content poses risks to exhibitors

The exhibitors are the last link in the value chain and the most dependent on the box office revenues. The biggest risk exhibitors face today is the lack of adequate quality content. As seen in the chart below, the fortunes of exhibitors are linked to the box-office performance of films, as even the food and beverage revenues, which offer the highest operating margins, are still dependant on people coming to the theatres.