How to Make a Profit in the New Hollywood

Despite a record-breaking 2015, the movie industry faces some troubling trends.
January 23, 2016, 2:00 PM UTC
Photograph by Jasin Boland/Warner Bros. Pictures/Courtesy Everett Collection

Despite a record-breaking 2015, the movie industry faces some troubling trends.

Imagine this scene: A group of aliens, pursuing their lifelong dream of making a movie, descend on Tinseltown. Their first stop? The majors, a.k.a. studios like the Walt Disney Co. (DIS), 20th Century Fox (FOX), and Comcast’s Universal (CMCSA) — the deep-pocketed creative forces behind Hollywood’s biggest blockbusters.

“We’ve got a great idea,” the extraterrestrials tell the respective studio heads. “It’s a movie about a hodgepodge team of space fighters trying to save the galaxy from an evil army!”

Disney passes because, well, it’s got Star Wars. But the other majors pass too. “Is it a sequel?” they ask. And upon hearing that it is not: “Have you considered independent financing?”

The interstellar visitors ask around, then hit up the financing divisions of major talent agencies, smaller independent studios, and even high-net-worth individuals. But they are met with skepticism at every turn. “How will your movie perform in China?” prospective funders ask them.

That stumps the aliens again. In desperation, they fly their spaceship north to Silicon Valley, where, they’ve been told, you can get money for just about anything. “We will make your movie,” the heads of a new production empire called Netflix (NFLX) tell them. “We will split it into 10 episodes and release them all at once, and we will give you $60 million.” As the aliens high-six one another, an exec adds, “But it won’t be a movie: It’ll be ‘must-watch television.’ ”

Unless you live in outer space, you know that the movie industry is undergoing massive change. In the U.S., edgy cable series and binge-worthy streaming shows have become most consumers’ must-sees — fodder for water-cooler talk and digressions on social media. Meanwhile, to build a global audience as its domestic one wanes, Hollywood has zeroed in on mega-sequels and remakes, flicks so big and recognizable that audiences can’t ignore them.

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For now, the formula is paying off. Hit sequels like Jurassic World and Star Wars: The Force Awakens helped push Hollywood’s global box office to a record $38 billion in 2015. But the industry faces troubling trends: It’s struggling to produce human-scale movies that break the action-sequel mold — and when it does make them, they often don’t make money. “There were a bunch of movies last year … that just didn’t catch on in the sea of big franchises,” says Paul Dergarabedian, senior analyst with box-office research firm Rentrak. Compared to a decade ago, fewer people are going to the movies, and if the remaining audience loses its taste for the big franchises, the industry could face a painful fall.

As Oscar season shines its annual spotlight on the tension between art and profit, it’s a good time to look at the business models that are on the rise in Hollywood — and to offer a preview of how they’ll play out in years to come.


Independents’ Day

THE FREE STATE OF JONES On the set of “Free State of Jones,” an upcoming release from newcomer studio STX Entertainment.Photography by Murray Close — (c) 2015 STX Entertainment, All Rights Reserved

The film business is insanity,” Matthew Vaughn, a British director and producer, says on a call from his home base in London. “I’ve done good by doing it my way.”

“Doing it your way” means bypassing Hollywood’s studio system to finance film production — but then using its distribution muscle when it’s time for theatrical release. Independent directors and producers aim to be asset-light: Unlike major studios, they don’t need to own production lots or employ ranks of full-time administrative staff. They can finance films project by project. And that can give them the flexibility to make a profit on films that don’t fit a blockbuster formula.

Vaughn, whose curriculum vitae includes 2000’s Snatch and 2015’s Kingsman: The Secret Service, has built a stable of financiers and a long-standing distribution relationship with 20th Century Fox. Kingsman, a tongue-in-cheek spy thriller about a secret organization that recruits a young street kid, was no stereotypical indie film — it had a star-laden cast (Colin Firth, Samuel L. Jackson) and Bond-like, whizbang weaponry. But by relying on his slate of investors to fund the movie’s production, Vaughn, who co-wrote, directed, and produced the film, kept the budget to a relatively modest $81 million. Fox took it from there with distribution, and it went on to gross more than $414 million globally.

A team of independent financiers isn’t easy to come by, of course. But as the majors have turned their attention to mega-sequels, some investors have flocked to fill the void. “It used to be that we’d have a project and need to actively source financing,” essentially going hat in hand to investors, says Roeg Sutherland, co-head of Creative Artists Agency’s film finance and sales group, which focuses on films with budgets of $15 million to $60 million (including recent successes Birdman and Sicario). “Now there is more money in the marketplace than there are projects.”

STX Entertainment, a new studio that also aims to fill the gap left by the majors, funded recent releases like The Gift, a profitable 2015 summer thriller, by inking a mix of sales of its equity and “slate financing” deals — in which investors put money into a grouping of movies and then receive a cut of their profit. The combined funding translates to about $1 billion per year at STX’s disposal, enough to develop and distribute 12 to 15 movies annually. Its equity investors include private equity firms TPG Growth and Hony Capital (Hony is based in China), plus such wealthy individuals as William “Beau” Wrigley and Gigi Pritzker. For slate financing, it enlisted Huayi Brothers Media, a Chinese film-production company. If you’re noticing a trend here — China and Hollywood working together — you’re onto something. See the section above.


Toy Story Meets the China Syndrome

A die-cast action figure from “The Force Awakens.”Courtesy of Disney

In mid-December, fans camped out for days along Hollywood Boulevard for the world premiere of Disney’s Star Wars: The Force Awakens. U.S. and Canadian moviegoers bought more than $100 million worth of advance tickets — obliterating records for movie presales. Still, as frenzied as this North American box-office demand has been, the real action — in the form of even higher revenue and profit margins — is unfolding elsewhere.

Star Wars–themed merchandising (from remote-controlled BB-8 droids to Kylo Ren’s red lightsaber) could bring in $6 billion this year, according to Goldman Sachs entertainment analyst Drew Borst. Licensing income from this kind of intellectual-property mining — think Happy Meal toys, T-shirts, and tie-ins with theme parks — is almost pure profit for the studios.

And, of course, there’s the foreign audience, which accounted for about 70% of Hollywood’s revenue in 2015 — and 54% of the $1.9 billion global take for The Force Awakens through mid-January. In the U.S., the number of tickets sold hit a 10-year low in 2014 (before ticking up last year), so studios must sell to the world — and in particular to China, which will likely overtake the U.S. as the world’s largest movie market in 2017.

KUNG FU PANDA 3, US poster art, Po (top, voice: Jack Black), 2016. TM and ©Twentieth Century Fox “Kung Fu Panda 3” is a co-production of DreamWorks Animation and Chinese investors.Photograph by 20th Century Fox, All Rights Reserved/Courtesy Everett Collection

China has a quota system for foreign films and rigid rules around revenue sharing. To crack the market, several Hollywood studios have partnered with Chinese companies. Last September, Warner Bros. (TWX) and China Media Capital, a state-backed investment firm, entered into a joint venture to develop a slate of Chinese-language films. Kung Fu Panda 3, opening in late January, is a result of another joint venture, between DreamWorks Animation (DWA) and several Chinese companies, launched with an investment of $330 million in 2012.

Studios find themselves having to cater not only to Chinese censorship laws, including how the government is portrayed and levels of violence allowed, but also to local tastes and humor. “You try to solve for reducing cultural nuances,” says Stacey Snider, co-chairman of Fox’s film studio and former head of DreamWorks. “Everyone thinks we [Hollywood studios] just dumb down movies, but we don’t.”



Netflix’s “Beasts of No Nation,” starring Idris Elba, was simultaneously released on its streaming platform and in theaters (where it made less than $91,000).Photograph Bleecker Street Media/Everett Collection

China is one of the few places on earth where you won’t find Netflix (the company is seeking permission to operate there). But the streaming service is available in more than 190 other countries. And it recently planted a flag in another new territory: the land of original feature film content.

In October it released Beasts of No Nation in theaters and on its streaming platform simultaneously. Beasts, a drama about a child soldier in Africa, showed in just 31 theaters, making less than $91,000 at the box office. Still, that’s all it needed to be eligible for Oscar nominations. (It didn’t get one, but two Netflix documentaries did.)

Netflix and its online brethren are gaining film-world clout as they gain viewers. Last summer, Netflix reportedly plunked down $60 million for the rights to Brad Pitt’s upcoming project, the military satire War Machine. (Creative Artists Agency helped broker the deal.) Not to be outdone, Amazon (AMZN) released its first feature film, director Spike Lee’s Chi-Raq, in theaters last year. In the past, productions like these might have struggled to attract A-list talent. But both companies now have not only the financial resources but also the gravitas to attract the likes of Brad Pitt.

Simultaneous theater and home release has long been a no-no in Hollywood, with theater chains denouncing it and studios fearing it will cannibalize revenue. Neither Netflix nor Amazon has figured out how to make the new economics work. But they’re betting that original films will boost their status as one-stop entertainment hubs, giving subscribers another reason to choose them over traditional moviemakers. That makes them a financial threat to the majors, even if their films aren’t yet. Studio heads know they eventually need to lead in digital or risk losing out to another screen-based center of gravity, the one in Silicon Valley.

A version of this article appears in the February 1, 2016 issue of Fortune with the headline “Making it in the New Hollywood.”