1. DreamWorks Animation SKG Distribution: Review and Recommendation by Loren K. Maxwell A Graduate Term Paper Submitted for Partial Fulfillment of the Requirements ofthe Degree of Master of Business Administration MKTG 781 Dr. Dwyer University of Cincinnati April 11, 2012

2. DreamWorks Animation SKG Distribution Abstract DreamWorks Animations current distribution agreement with Paramount expires onDecember 31, 2012. Primarily at issue is the 8% distribution fee Paramount currently chargesfor marketing and distribution services. This study performs an analysis of the film industry,DreamWorks Animation, and the case details, to include exploring the options of 1) renewingwith Paramount, 2) securing an agreement with another distributor, or 3) pursuing self-distribution, to reach several conclusions and provide a recommendation. Absent information concerning actual options DreamWorks Animation is pursuing or hasbeen offered, the recommendation is for DreamWorks Animation to secure an agreement with amajor distributor and to show a particular interest in securing with Warner Bros., although it isdoubtful an 8% distribution fee can realized again. For less than the 8% distribution fee,Lionsgate might be considered, but at greater risk. DreamWorks Animation should not pursueself-distribution. ii

3. DreamWorks Animation SKG Distribution TABLE OF CONTENTSABSTRACT iiLIST OF FIGURES viiLIST OF TABLES viiINTRODUCTION 1 Statement of the Problem 1 Need for the Study 1 Research Question 2METHODOLOGY 3 Type of Study 3 Sources Utilized 3 Assumptions 5 Limitations 6 Key Terms 8INDUSTRY ANALYSIS 12 Conceptual Model of the Film Industry 12 The Film Industry 17 Hollywood Dominance 17 Producers, Distributors, and Exhibitors 18 The Role of the Distributor 18 The Producer and Distributor Relationship 20 The Distributor and Exhibitor Relationship 22 iii

4. DreamWorks Animation SKG Distribution Sequencing and Windowing 25 Profit Maximizing and Shifts 25 Piracy 32 Customer as Ultimate Arbiter 33 Key Markets 34 Domestic Theatrical Market 34 International Theatrical Market 43 Domestic Post-Theatrical Market 45 International Post-Theatrical Market 48 The Digital Animation Industry 50 Traditional versus Digital Animation 50 Family feature Film Market 52 Digital Animation Studios 52COMPANY ANALYSIS 58 Overview 58 Revenues 58 Strategy 61 Franchises 61 International Market 63 Portfolio 65 3-D 67 Strengths, Weaknesses, Opportunities, and Threats 67 Strengths 67 iv

5. DreamWorks Animation SKG Distribution Weaknesses 69 Opportunities 71 Threats 72CASE ANALYSIS 74 DreamWorks Animation-Paramount Distribution Agreement 74 Terms 74 Distribution Fees 75 Marketing and Distribution Expenses 78 Portfolio Value of DreamWorks Animation 79 Recent Developments 83 Dispute over Distribution Fee 83 Paramounts Portfolio 84 DreamWorks Animation Exploring Option 86 Analysts Insights 87 Overview of Distribution Options 88 Requirements 88 Options 91 Renew with Paramount 91 Secure an Agreement with a Different Distributor 93 Pursue Self-Distribute 99 Conclusions 102 DreamWorks Animation Must Mitigate Risk from Its Lack of Diversification 102 v

6. DreamWorks Animation SKG Distribution The Number of Potential Distributors is Limited 103 The Bargaining Power for Distribution Fees Has Shifted 103RECOMMENDATION 105REFERENCES 106APPENDICES 121APPENDIX A-MAJOR AND MINI-MAJOR STUDIOS, 1995-2012 122APPENDIX B- MAJOR AND MINI-MAJOR STUDIOS, 2009-2011 124APPENDIX C-DIGITALLY ANIMATED FAMILY FEATURE FILMS 126APPENDIX D-PERFORMANCE OF DIGITALLY ANIMATED FILMSCOMPARED TO TRADITIONALLY ANIMATED FILMS SINCE 1995 130APPENDIX E-DREAMWORKS ANIMATION ANNUAL REVENUES BYFILM 133APPENDIX F-CONCISE GLOSSARY FOR DREAMWORKSANIMATION SKG DISTRIBUTION STUDY 136 vi

7. DreamWorks Animation SKG Distribution LIST OF FIGURESFigure Page1 Simple conceptual model of the film industry showing production, distribution,and exhibition. 132 Simple conceptual model of the film industry with different markets. 143 Conceptual model of film industry 154 Comparison of Top Tier Digital Animation Studios; Adjusted Worldwide Grossin Millions against Metascore 555 Comparison of Digital Animation Studio Tiers; Adjusted Worldwide Gross inMillions against Metascore 56 vii

8. DreamWorks Animation SKG Distribution LIST OF TABLESTable Page1 Consumer Price Index, 1995-2012 102 Major theatrical exhibition chains 243 Shrinking Window Between Theatrical Release and Post-Theatrical Release 274 Approximate cost of film viewing per person-hour, 2010 415 Comparison of Substitute Products, 1995-2011 426 Worldwide Theatrical Gross in Billions, 1995-2011 447 Domestic Home Video Gross in Billions, 1999-2010 488 European Home Video Gross in Billions, 1999-2010 499 Japanese Home Video Gross in Billions, 1999-2010 4910 Growth of Digitally Animated Films and the Decline of Traditionally AnimatedFilms, 1995-2012 5111 Digital Animation Studios 5412 Digital Animation Film Studios at the Oscars 5713 DreamWorks Animation DVD Sales, Ranked by of Adjusted Domestic Gross inMillions of Accounted for DVD Sales, 2007-2012 5914 Digital Animation Studio DVD Sales, Ranked by of Adjusted Domestic Gross inMillions of Accounted for DVD Sales, 2007-2012 6015 DreamWorks Animation Franchise Films, 2006-2012 6416 Upcoming DreamWorks Animation Releases 6617 Domestic and Worldwide Growth of 3-D, 2005-2011 6718 Paramount Theatrical Distribution Fee in Millions Per DreamWorks AnimationFilm 76 viii

9. DreamWorks Animation SKG Distribution19 Estimated DreamWorks Animation Worldwide Revenue in Millions Per Film 7720 Estimated Paramount Distribution Fee by Film 7821 Average Production and Marketing Costs in Millions for MPAA Films, 2001-2007 7022 Paramount Distributed Films With $100 Million or More Adjusted DomesticGross Released Since 2006 8123 DreamWorks Animation Compared to Paramount Releases in Millions from2006-2012 8224 The Weinstein Companys Top Films in Adjusted Worldwide TheatricalRevenue in Millions 9625 Lionsgate Top Films in Adjusted Worldwide Theatrical Revenue in Millions 98 ix

10. DREAMWORKS ANIMATION SKG DISTRIBUTION INTRODUCTION Statement of the Problem DreamWorks Animation is the largest animation studio in the world and has released atotal of 23 feature films since 1998 (DreamWorks Animation SKG, 2012b). Beginning in 2006,DreamWorks Animation films have been distributed by Paramount Pictures, a subsidiary ofViacom, under an agreement that expires on December 31, 2012 (DreamWorks Animation SKG,2012b). Although Paramount offered to extend the terms for an additional year, DreamWorksAnimation rejected the offer (Frtiz, 2011a) to explore more favorable distribution options.Currently, the three most likely scenarios will be to either 1) renew an agreement withParamount, 2) secure another studio to distribute DreamWorks Animation films, or 3) pursueself-distribution. Need for the Study The film industry is highly fractured, dynamic, and complex, with distribution holding akey position between the production and exhibition of films. As competing producers vie for ashare of an increasingly crowded market, a misstep in the distribution of a film can be disastrous.This is especially true for an independent producer releasing a limited number of films targetedat a limited audience and with a small film library to balance the risk of losing millions of dollarsin production costs on an underperforming theatrical release. Even a successful release canrealize much less than its full potential if distribution is handled poorly. 1

11. DREAMWORKS ANIMATION SKG DISTRIBUTION Research Question This study analyzes the film industry, DreamWorks Animation, and, to the extentinformation is available, the specific case of the expiring DreamWorks Animation andParamount distribution agreement, and makes a recommendation in favor of one of the threeoptions DreamWorks Animation is considering. 2

12. DREAMWORKS ANIMATION SKG DISTRIBUTION METHODOLOGY Type of Study This study to determine how DreamWorks Animation should distribute their films isqualitative using the grounded theory method. This method was chosen because of the lack ofquantitative data and the consideration of intangible benefits and costs of the case. The industry analysis focuses primarily on 1995 forward, the period starting with the firsttheatrical release of a digitally animated feature film, with an increasing emphasis on morerecent years. The company analysis focuses primarily on 2006 forward, the period starting withDreamWorks Animations current agreement with Paramount Pictures for distribution, againwith an increasing emphasis on more recent years. The case analysis focuses primarily on theagreement between DreamWorks Animation and Paramount and the events surrounding thepotential to either renew the distribution agreement with Paramount, secure another distributor,or pursue self-distribution, again with an increasing emphasis on more recent years. In all threeanalyses, particular weight is given to data that is determined to have a significant impact on thefuture of the industry or company. Older data is examined where appropriate. Sources Utilized For this study, a variety of books, periodicals, electronic databases, internet websites,industry reports, press releases, and filings with the U.S. Securities and Exchange Commissionwere considered. Topics investigated for this study were the film industry, DreamWorks 3

13. DREAMWORKS ANIMATION SKG DISTRIBUTIONAnimation, and the current distribution agreement between DreamWorks Animation andParamount. For the particular workings of the film industry, the most useful sources were the textbooks Entertainment industry economics by Vogel (2011) and The business of media distributionby Ulin (2010). Aside from the film industry, both explored the business of creative industries ingeneral and should be considered seminal works on the subject. Similarly, The movie businessbook, third edition, edited by Squire (2004) was useful for an overview of the film industry,although some chapters were already dated given the advances in distribution technology in theperiod since its publication. Industry trade organizations, specifically the Motion Picture Association of America(MPAA), the National Association of Theater Owners (NATO), the Digital Entertainment Group(DEG), the Digital Entertainment Group-Europe (DEGE), and the International Video Federation(IVF), were referenced for current numbers on industry economics and current topics in theirrespective areas. Also used in the analysis of the film industry were several industry publicationssuch as The Hollywood Reporter, Deadline, and The Wrap, business publications such asBusiness Week, Forbes, and Fortune, general news publications such as USA Today, Los AngelesTimes, and New York Times, and news sites such as CNN. Also, several academic treatments ofthe film industry were found, primarily relating to such subjects as the timing of releases and thestructure of contracts between producers and distributors and between distributors and exhibitors.Finally, Box Office Mojo (www.boxofficemojo.com) and The Numbers (www.the-numbers.com) were referenced concerning all domestic and international theatrical revenues forfilms while Metacritic (www.metacritic.com) and Rotten Tomatoes (www.rottentomatoes.com)were considered for all critical reviews of films. 4

14. DREAMWORKS ANIMATION SKG DISTRIBUTION DreamWorks Animation filings with the U.S. Securities and Exchange Commission andtheir related earnings conference call transcripts were considered the primary source for allinformation concerning DreamWorks Animation as well as any press releases from the company.Also useful were several investor sites such as Seeking Alpha (www.seekingalpha.com) andMotley Fool (www.fool.com), as was an exceptional analysis of DreamWorks Animation byAndrew August (2011) at Frogs Kiss (www.frogskiss.com). Concerning the distribution agreement with Paramount, DreamWorks Animation filingsand related earnings conference call transcripts were again considered the primary source for allinformation. Additionally, industry publications such as The Hollywood Reporter, Deadline, andThe Wrap proved invaluable when examining the most recent updates, as were various generalnews publications, in particular the Los Angeles Times. Finally, DreamWorks Animation Investor Relations was contracted for additionalinformation on both the company and the specifics of the agreement with Paramount. The reply,while polite, referred to the public information available in SEC filings and press releases. Assumptions This study makes the assumption all firms are profit maximizing, meaning their decisionswill be consistent with the sole goal of maximizing economic profits (Nicholson and Snyder,2011). This is assumed to be particularly true of public companies, such as DreamWorksAnimation and Paramounts parent Viacom. Additionally, for this study, the assumption isextended to trade associations, such as the Motion Picture Association of America. Althoughtrade associations are not necessarily directly driven by profits, they seek to advance the business 5

15. DREAMWORKS ANIMATION SKG DISTRIBUTIONinterest of their members, which are assumed to be profit maximizing firms. Although in truthpersonal and professional relations undoubtedly impact business decisions, this simplifyingassumption effectively excludes from consideration a sizeable volume of salacious informationpertaining to DreamWorks Animation CEO Jeffrey Katzenbergs relationship with the majorstudios, specifically his contentious departure from Disney in 1994 (Borden, 2009), and torecently reported acrimony toward Brad Grey, chairman and CEO of Paramount (Masters,2011b). Additionally, in instances lacking any other information, it was assumed domestictheatrical revenue would suffice as a measure of success for a particular film, producer,distributor, or exhibitor. Many sources have noted a strong correlation between the domestictheatrical market and subsequent markets, although the correlation is to varying degrees and arange of other market and film-specific factors . . . can have a significant impact on a filmsperformance in the international theatrical market as well as in the worldwide homeentertainment and television markets (DreamWorks Animation SKG, 2012). Limitations As with any study, limitations due to incomplete or imperfect information are inherent.Each known limitation is reviewed with a short comment about the mitigation strategy for thelimitation. Although the sources utilized proved invaluable, unavailable were the undoubtedlyinnumerable discussions and arrangements which occurred outside of the attention of the media.No assumption is made concerning information not reported through the media. Additionally, 6

16. DREAMWORKS ANIMATION SKG DISTRIBUTIONmost contemporary sources, especially the trade publications, often report industry rumors whichmay or may not surface later as verified fact. For this study, rumors are identified as such andheavier consideration is given to information reported as fact. A useful source of information was investment oriented sites, however, it is noted herethat the purpose of investment reporting is to inform actual or potential stock investors on thevalue of a particular stock relative to the condition of the market as opposed to an objectiveanalysis concerning the financial wellbeing of a company. Speculative reporting is the norm asis the exploration of different scenarios and their perceived impact on a companys stock price.In short, investment reporting often centers on a companys stock as opposed to the companyproper. As a pertinent example, the lack of specific public statements by DreamWorksAnimation concerning their distribution options creates uncertainty in the stock market and thusimpacts the stock price, although this does not necessarily equate to DreamWorks Animationlacking distribution options and suffering an actual threat to their future revenue. For this study,all such discussions centering on a companys stock price were not factored although relevantinformation might have been collected and used. Another limitation in investment reporting is the frequent use of unreferenced estimates,making it difficult to determine their validity and reliability. This uncertainty in the estimates isfurther compounded by the speculative nature of investment reporting. In all such cases, aneffort was made to validate an estimate with an outside source or to use it in conjunction with anoutside source that contained a similar estimate. Similarly, although DreamWorks Animations filings proved to be an exceptional sourceof information, it is also noted that its primary purpose is to report to investors rather than beused for a business analysis. Although the purposes overlap, they are not exactly equivalent. As 7

17. DREAMWORKS ANIMATION SKG DISTRIBUTIONa result, language in filings and associated earning calls is often neutral and purposefully vagueto be mindful of the ramifications on the companys stock price. The use of these reports andtheir associated earnings calls were limited to non-controversial information (i.e., the overviewof the business as provided in Item 1 of the Form 10-K) and for the first source for anyinformation concerning DreamWorks Animation. Another limitation is the surprising lack of public data concerning certain relevantmarkets, specifically large segments of the international theatrical market, particularly China andIndia, and much of the post-theatrical market. Figures for VHS, DVD, and Blu-ray sales andrentals for specific films are woefully incomplete or unavailable, especially prior to 2006.Similarly, there seems to be no source for comprehensive data on digital distribution, such assales and rentals through iTunes or Netflix. However, as noted above, it is assumed the domestictheatrical market is well correlated to subsequent markets, albeit to varying degrees(DreamWorks Animation SKG, 2012b). Finally, and perhaps most limiting for this particular study, is the lack of information foractual distribution proposals and options that DreamWorks Animation may be weighing in lightof the imminent expiration of their agreement with Paramount. As a result, the recommendationof this study is of necessity fairly generic and does not and cannot endorse a particular optionwith any specification. If given complete and perfect information, it is quite possible an entirelydifferent conclusion would have been arrived at other than the recommendation presented. Key Terms Several key terms specific to this study are used that warrant the early exploration of their 8

18. DREAMWORKS ANIMATION SKG DISTRIBUTIONdefinitions to prevent confusion. A concise glossary is provided in Appendix F. Due to a variety of production methods and occasionally a mixture of productionmethods, such as a film combining live and animated elements, for this study a digitallyanimated film specifically refers to any film whose Genre is identified as Animation Computer by Box Office Mojo and excluding any whose Genre is also indentified asAnimation Motion Capture by Box Office Mojo or whose Production Method was identifiedas Animation/Live Action by The Numbers. A traditionally animated film refers to any filmwhose Production Method is listed as Hand Animation by The Numbers while a stop motionanimated film refers to any film whose Production Method is listed as Stop-Motion Animationby The Numbers. Also, the scope of the release can be relevant to distinguish films that are meant tocompete on a national scale. Although some studies consider a film to have a wide release if itplays on 600 screens concurrently, for this study a feature film refers to any film shown on 2,000or more screens in domestic theaters as reported by either Box Office Mojo or The Numbers. Also, films tend to target different audiences, which are often seen in their ratings and thegenre they take place in. For this study, a family film is any film rated G or PG by theMotion Picture Association of America and classified in the Adventure or Comedy Genre byThe Numbers. This study uses key terms cumulatively, such as discussing digitally animated familyfeature films, which have all the above characteristics. All DreamWorks Animation releases areeither digitally animated family feature films, traditionally animated family feature films, orstop-motion animated family feature films. Occasionally, the use of inflation adjusted dollar amount is helpful or necessary for 9

19. DREAMWORKS ANIMATION SKG DISTRIBUTIONcomparisons. In such cases, this study will refer to those amounts as adjusted. Adjusted dollarshave been calculated to their 2010 equivalents using the Consumer Price Index from the U.S.Department of Labor Bureau of Labor Statistic according to Table 1. Table 1 Consumer Price Index, 1995-2012 Year CPI Year CPI Year CPI 1995 1.4308 2001 1.2319 2007 1.0517 1996 1.3898 2002 1.2121 2008 1.0128 1997 1.3586 2003 1.1851 2009 1.0164 1998 1.3378 2004 1.1543 2010 1.0000 1999 1.3089 2005 1.1165 2011 0.9694 2000 1.2663 2006 1.0816 2012 0.9506 Of note is that this method differs significantly from the method used by the website TheNumbers, which uses the ratio of the average ticket price for different years to perform theirinflation adjusted calculations. For this study, The Numbers method is considered inferior tousing the Consumer Price Index. Using adjusted dollars for worldwide theatrical revenue, it is possible to reasonably groupanimation studios that have exceeded specific thresholds. For this study, a top tier digitalanimation studio is any studio that has realized worldwide adjusted theatrical revenue of over $1billion for digitally animated family feature films. As of April 10, 2012, four studios have metthis criterion: DreamWorks Animation, Disneys Pixar, Foxs Blue Sky Studios, and DisneyAnimation Studios. A middle tier digital animation studio is any studio that is not a top tierstudio, but has released at least one digitally animated family feature film that realizedworldwide adjusted theatrical revenue of $200 million or higher. As of April 10, 2012, fourstudios have met this criterion: Universals Illumination Entertainment, Animal Logic, IndustrialLight & Magic, and Sony Pictures ImageWorks. The top tier digital animation studios and 10

20. DREAMWORKS ANIMATION SKG DISTRIBUTIONmiddle tier digital animation studios are considered the major digital animation studios. Finally,a bottom tier digital animation studio is any studio that is not a top or middle tier studio, but hasreleased at least one digitally animated family feature film. As of April 10, 2012, fifteen studioshave met this criterion. Additionally, the film industry has several tiers of distributors as well. Vogel (2011)defines a major studio as a company with an important and long standing presence in bothproduction and distribution with substantial library assets and some studio production facilities.For this study, a major studio can be quantitatively identified as a distributor who captures 10%or more of the total adjusted domestic theatrical gross. As of April 10, 2012, there were sixmajor studios: Disney, Fox, Paramount, Sony, Universal, and Warner Bros. Also, a second tierof distributors are normally identified as well, commonly referred to as the mini-majors. Ulin(2010) defines a mini-major studio as a company that is independent, can offer broaddistribution, and consistently produces and releases a range of product, but is largelydistinguished from a major by distribution capacity. For this study, a mini-major studio can bequantitatively identified as a distributor who captures more than 1% but less than 10% of thetotal adjusted domestic theatrical gross. As of April 10, 2012, there were two mini-majorstudios: Lionsgate and The Weinstein Company, although MGM is identified as a previous mini-major studio. 11

21. DREAMWORKS ANIMATION SKG DISTRIBUTION INDUSTRY ANALYSIS Theres no business like show business Irving Berlin Conceptual Model of the Film Industry Few industries capture the interest of the public like show business. It is commonlybelieved to be a mythical realm worthy of the stories it produces, where powerful mogulsexecute cutthroat deals and bold Machiavellian maneuvers, where its famous citizens teeterperilously between luxurious excess and ruinous scandal, and where the small town girl navelybelieves she is only one wish upon a star from avoiding the boulevard of broken dreams. Anyother industry can seem pedestrian by comparison. In truth, though, the everyday minutia of the film industry is perhaps much more prosaicthan Hollywood itself might admit. Agreements are settled perhaps more often in conferencerooms and occasionally court rooms by businessmen and lawyers as opposed to in smokybackrooms by anonymous power brokers and their lackeys. This is not to say, however, the film industry is the same as the petroleum industry or thefishing industry. The film industry is one of the creative industries, which are characterized byseveral economic properties (Caves, 2000): - Creative industries are driven by new and unique products and are therefore subject to highly uncertain demand. - Creative workers care greatly about what they produce as opposed to workers in other industries whose labor tends to be primarily functional and standardized. 12

22. DREAMWORKS ANIMATION SKG DISTRIBUTION - Many creative ventures, such as films and live performances, require workers with diverse and specialized skills. - Creative products tend to be differentiated both vertically and horizontally. - Creative products can differ in many small ways for an infinite variety. - Many creative ventures require close temporal coordination by all contributing elements. - Royalties and rents are often collected in small lump sums over long periods of time. In addition to examining the economic properties for a creative industry, the film industrycan be further explored through the development of a conceptual model with three distinctcomponents as the foundation: production, distribution, and exhibition, as illustrated in Figure 1.Production refers to all the activities required to produce one copy of a film, while distributionrefers to all the activities related to marketing and delivery of a film to exhibitors, and exhibitionrefers to activities performed to permit the consumption of the film (Eliashberg, Elberse, andLeenders, 2006). Figure 1 Simple conceptual model of the film industry showing production, distribution, and exhibition. The next step in the development of the conceptual model is to consider the two generalmarkets for theatrical release: the domestic market, which is the United States, Canada, PuertoRico, and Guam (Glossary of movie business terms, n.d.), and the international market, whichis all markets outside the domestic market (Glossary of movie business terms, n.d.). These 13

23. DREAMWORKS ANIMATION SKG DISTRIBUTIONcombine to form the worldwide market (Glossary of movie business terms, n.d.). As illustrated in Figure 2, release into the international market can be further segmented,in this case into the notional regions of Region 1 and Region 2. This segmentation is typicallyalong national boundaries. Also shown in Figure 2 is the ability of the producer to dividedistribution rights among more than one distributor, in this specific instance using the samedistributor for the domestic market and Region 1 but a different distributor for Region 2. Notshown is that a producer can also use multiple distributors for the same market if the distributionrights are parceled out in such a manner.Figure 2 Simple conceptual model of the film industry with different markets. In this notional example, Region 1 will begin exhibition slightly after the domesticmarket and slightly before Region 2. As well, the film will be exhibited for extended time inRegion 1 as compared to Region 2 and the domestic market. This represents sequencing into thevarious markets as well as windowing the length of the exhibition. If no other window overlaps,as is the case with the first portion of the domestic theatrical release, the exhibiting window isconsidered to have exclusivity, from an exhibitors standpoint the most desirable characteristic ofany windows (Ulin, 2010). With the next iteration of the conceptual model in Figure 3, film distribution begins to 14

24. DREAMWORKS ANIMATION SKG DISTRIBUTIONbecome exponentially more complex with the introduction of post theatrical markets,particularly with the multitude of exhibition methods available. For simplicity, only twonotional exhibition methods are shown for the post theatrical, but home video (VHS, DVD, andBlu-ray), pay per view television, cable television, network television, syndication, video-on-demand, etc., represent but a few of the exhibition methods currently available in a rapidlygrowing market.Figure 3 Conceptual model of film industry In addition to the relationships and concepts discussed above, the expansion of theconceptual model introduces a distributor who utilizes another distributor, specifically where thedomestic theatrical distributor uses another distributor to penetrate the Region 1 market for 15

25. DREAMWORKS ANIMATION SKG DISTRIBUTIONNotional Exhibition Method 1. This could be due to any number of reasons, such as the sub-distributor having familiarity in Region 1 or perhaps familiarity in Notional Exhibition Method 1or perhaps even exclusive ability to utilize Notional Exhibition Method 1 in Region 1 due tolegal or technological constraints. An example might be cable television with a monopoly inRegion 1. Also depicted is additional production prior to distribution into Region 1 for NotionalExhibition Method 2. International markets often require additional production, such assubtitling or dubbing (Eliashberg, Elberse, and Leenders, 2006) or editing for controversialcontent. Given the vast number of international markets and exhibition methods, the number ofversions for a film can easily reach 150 (Ulin, 2010). However, almost any market offers thepotential for additional production, such as special features in DVDs and Blu-rays. In reality,each market and exhibition method combination would most likely be touched by additionalproduction beyond the making of a film as would the same market and exhibition method in alater window, such as releasing an anniversary edition DVD of a film 10 years after it hadalready been through a typical sequencing and window cycle. Even within the same market,exhibition method, and window, a film can benefit from additional production if it cansignificantly differentiate the exhibition for the consumer, such as a theatrical release of a film inboth 2-D and 3-D. Even a casual review of film industry trade publications demonstrates the aboveconceptual model is elementary, especially when compared to the overwhelming number ofproducers, distributors, and exhibitors, the dizzying number of markets and their individualnuances, and the manifold and increasing number of exhibition methods cycling through thevarious stages of their product life cycle. Proper sequencing and windowing of a film, the key to 16

26. DREAMWORKS ANIMATION SKG DISTRIBUTIONprofit maximizing, can become immensely complex with a vast number of competing interestsfrom producers, distributors, and exhibitors. The key components, relationships, and conceptsillustrated in the conceptual model will be referenced in the remainder of the study. The Film Industry Hollywood Dominance A prerequisite to fully understanding the film industry is the appreciation of the historicdominance Hollywood-based studios have enjoyed in practically every significant market(Vogel, 2011). From the beginning, domestic filmmakers held several early advantages overtheir European rivals, namely 1) the worlds largest domestic market characterized by a diverseimmigrate culture, 2) a well-developed industrial organization as compared to the largelyartisanal production and distribution systems abroad, and 3) an appealing ideology of optimismand a practice of producing happy endings in contrast to the often stark and morose fade-outscommon in early foreign films (Trumpbour, 2002). Additionally, this dominance is unlikely toend soon due to 1) the public good/joint consumption nature of films, where the consumption byone consumer does not reduce or detract from the consumption by another, 2) the greateropportunity to amortize films in the post theatrical market across a relatively large populationwith a strong breadth and depth of exhibition methods, and 3) a minimized cultural discount onthe product through the use of English, the second most popular language in the world and usedby the majority of speakers residing in the wealthiest nations (Vogel, 2011). Other reasons citedfor this dominance include historical happenstance, technological innovation, availability of 17

27. DREAMWORKS ANIMATION SKG DISTRIBUTIONcapital, application of marketing prowess, and culture (Vogel, 2011). Because the United States has long been the dominant exporter of film and televisionprogramming, the net trade balance for these products has been at least $4 billion per year(Vogel, 2011) with an $11.9 billion surplus in 2009, which accounted for 8% of the total U.S.private sector trade surplus in services (MPAA, 2011). Interestingly, as with any industry with astrong trade surplus, the film industry is subject to fluctuations in the strength of the dollar in theworld economy (Aft, 2004). A weak dollar, where revenue collected in foreign currenciesequates to more dollars, can help offset production costs originally incurred in dollars (Aft,2004). Conversely, a strong dollar tends to hurt the film industry (Aft, 2004). Producers, Distributors, and Exhibitors Role of the Distributor Prior to 1948, the larger companies in the film industry, referred to as studios, generallycontrolled all three stages of production, distribution, and exhibition (Fellman, 2004). Under thissystem, studios often utilized the real estate value of their theater locations as collateral tofinance the production costs of films (Vogel, 2011). However, in a landmark decisionconcerning vertical integration antitrust cases, the studios divested themselves of theaterownership under a consent decree in U.S. v. Paramount Pictures, Inc., dismantling the oldHollywood studio system and ushering in the modern era of the film industry (Ulin, 2010).Now, absent the ability to finance production through theater locations and lacking the ability tocontrol exhibition, distributors became more selective about the films they risked production 18

28. DREAMWORKS ANIMATION SKG DISTRIBUTIONcosts on, in turn becoming the pivotal players that controlled the flow of content to consumers(Vogel, 2011). In short, the major studios evolved into distribution operations, where buyingintellectual properties, hiring movie stars, and financing films is to some extent simply a pretextto owning and controlling distribution rights (Ulin, 2010). Filmmaking as a commercial venture is a highly risky proposition, where most majorfilms do no better than break even with extreme deviations in both directions (Vogel, 2011) andthe few highly successful films must pay for the many underperforming ones (Vogel, 2011). Thetop 20 grossing films in any year will account for around 40% of the years revenues and 10% ofthe films will generate 50% of the revenue (Vogel, 2011). In terms of profits, the prospect iseven bleaker, where an estimated 5% of films generate 80% of theatrical exhibition profits(Vogel, 2011). For a studio to be successful, a highly successful film often requires anapproximately 20% return simply to offset losses from other films (Ulin, 2010), not to mentionthe many films abandoned during or perpetually stuck in production (Ulin, 2010). To a large degree, distributors can be properly viewed as managers of a specializeportfolio consisting of films (Ulin, 2010). A simple application of modern portfolio theorywould drive studios to adjust and mitigate risk exposure through diversification by balancing amix of high-, medium-, and low-budget films in their yearly releases (Vogel, 2011). Accordingto data compiled from The Numbers, the six major studios averaged between around 23 and 42releases annually from 1995 to 2012. Statistically, more films ensure consistent deviations inrevenue and profits, and therefore temper risk, but it is also noted films graduating throughproduction are not truly random samples, but rather selected based on their potential forprofitability, stacking the deck considerably in favor of the distributor (Ulin, 2010).Additionally, films that become unprofitable during production can either be abandoned or 19

29. DREAMWORKS ANIMATION SKG DISTRIBUTIONreprioritized to improve its chances (Ulin, 2010). As a final consideration for distributorportfolios, film libraries can also be considered as a low risk source of profit (Vogel, 2011),although their effectiveness can be subject to price erosion (Ulin, 2010). Major studios have historically accounted for approximately 90% of domestic theatricalrevenue (Vogel, 2011). Using data compiled from the Numbers, Appendix A shows majorstudios received 89.4% of the domestic theatrical revenue from 1995 to 2012 although they onlyreleased 35.2% of the films. As perhaps evidence of a growing independent movement madepossible by decreasing production and distribution costs, Appendix B shows major studios onlyaccounted for 26.7% of film releases from 2009 to 2011. However, they still managed to take ina disproportionate 85.0% of domestic theatrical revenue. The Producer and Distributor Relationship Intuitively, the relationship between producer and distributor seems contentious bynature. After investing perhaps years of work, millions of dollars, and buckets of sweat equityinto a project over which they most likely enjoyed absolute authority, the great culmination of aproducers effort is to essentially hand over a completed film to a distributor just as it is ready forconsumption (Ulin, 2010). This poses significant risk to a producer who wants as manyopportunities as possible to guarantee the success of a film, although, under the portfolio model,a distributor may be ready to quickly abandon an underperforming film in favor of divertingmarketing and distribution resources to another (Ulin, 2010). Although producers are generallygreatly concerned with the quality of their creative work (Caves, 2000), from the distributorsportfolio perspective, producers are little more than efficient sources for developing content for 20

30. DREAMWORKS ANIMATION SKG DISTRIBUTIONthe portfolio (Ulin, 2010). As such, the producers power in the relationship comes directly fromthe films distribution rights. Because a film is intellectual property, and therefore infinitely indivisible, a filmscopyright owner could parcel off each discreet distribution right to a different distributor (Ulin,2010). Typically it would benefit the producer to do so in order to reduce or eliminate cross-collateralization of the revenues, where revenues from one territory are used to offset losses fromanother (Blume, 2004). By limiting cross-collateralization, a loss is compartmentalized and doesnot impact the potential for revenues in other distribution avenues (Vogel, 2011). Thissignificantly shifts the risk to the distributor, and as such, distributors are naturally reluctant toseparate these rights unless other arrangements for compensation can be made (Vogel, 2011). Producer and distributor agreements essentially boil down to the specification of theallocation of revenue streams, to include specifying distribution fees, ownership rights, andadvertising and marketing commitments, along with details concerning account statementpreparation and audits (Vogel, 2011). Also commonly structured into producer and distributoragreements is the degree of creative control, which normally serves to mitigate risk on the part ofthe distributor, especially if the distributor is serving as a financier for all or part of a film. Forexample, a step deal provides funding in steps that allow the financier the ability to advanceadditional funds contingent on predetermined conditions (Vogel, 2011). These predeterminedconditions typically involve one of the essential ingredients of a production: screenplay, director,producer, principle cast, and budget (Vogel, 2011), such as the financier approving the draft of ascreenplay or requiring the producer to secure certain casting choices. When financing on the part of a distributor is involved, distribution fees are commonly30% for domestic theatrical release, 40% for international distribution and television syndication, 21

31. DREAMWORKS ANIMATION SKG DISTRIBUTIONand 15% for other distribution avenues (Vogel, 2011). With a high barrier to entry for majordomestic distribution operations (approximately $70 million per year in operating costs in anindustry offering substantial risk), distribution fees are not especially sensitive to bargainingpressures, although notable exceptions do exist (Vogel, 2011). For producers who can finance from other sources and essentially deliver a completedfilm, distribution fees as low as between 12.5% and 17.5% can be realized (Vogel, 2011). Forexample, after the success of Toy Story, Pixar negotiated a seven-year, five-film agreement withDisney for a 12.5% distribution fee (Burrows, 1998b). Also, although rare, a limited number ofwealthy and powerful producers who can shoulder all the risk and self-financing for a film cansecure even lower distribution fees if the films likelihood for success is particularly high (Ulin,2010). Following the success of Iron Man, Marvel Entertainment negotiated an 8% distributionfee with Paramount for its Marvel Cinematic Universe franchise of films (Vogel, 2011). GeorgeLucas was able to negotiate a distribution fee of just 6% with Fox for the second Star Warstrilogy (Vogel, 2011). Currently, DreamWorks Animations agreement with Paramount is for an8% distribution fee (DreamWorks Animation, 2011). From the perspective of any particular film, distribution fees may generally be regardedas profit (Vogel, 2011). However, from a distributors portfolio perspective, profit from anyparticular film is first used to offset unrecovered distribution costs from other films (Vogel,2011). The Distributor and Exhibitor Relationship The relationship between a distributor and a particular exhibitor depends heavily on 22

32. DREAMWORKS ANIMATION SKG DISTRIBUTIONwhere the exhibitor sits in the sequencing and windowing of films and where the exhibitionmethod is at in its product life cycle. Contracts can take a variety of shapes, but termsnecessarily specify the details of the exhibition rights, to include length of the exhibition windowas well as time and territorial exclusivity and perhaps, at least in the case of theatrical exhibition,conditions such as auditorium size (Vogel, 2011). Although there are many variations, conventional contracts between distributors andtheatrical exhibitors call for a sliding percentage of the revenue after allowances for theexhibitors expenses, referred to as the nut, which consists of items such as rent and utilities(Vogel, 2011). The nut is negotiated in advanced and is normally higher for theaters with betterlocations and larger and newer facilities (Vogel, 2011) and is often understood or assumed toactually be higher than true theater expenses (Vogel, 2011). In the first week, after the nut issubtracted, revenues are typically split with 90% going to the distributor and 10 % to theexhibitor (Vogel, 2011). Generally, every two weeks the split is adjusted in favor of theexhibitor by 10% (Vogel, 2011). Over the life of a theatrical exhibition, distributors normally receive about half of revenuewhile theaters retain the other half (Vogel, 2011). DreamWorks Animation reports theaters passbetween 49% and 56% of domestic theatrical revenues to Paramount (DreamWorks AnimationSKG, 2012b). Although the amounts are roughly equal over the life of a theatrical release, filmstypically experience a strong opening and then fade over time (Ulin, 2011) and the slidingpercentage agreement is structured to allow the distributor the fastest recuperation of distributionand marketing expenses (Vogel, 2011). Of note, the most significant source of profit for exhibitors is concession stand sales,whose profit margins on individual items often exceed 50% and can reach up to 90% on items 23

33. DREAMWORKS ANIMATION SKG DISTRIBUTIONsuch as popcorn (Vogel, 2011). In fact, concession sales for some theaters account for 90% ofprofit (Vogel, 2011) and are often the difference in in a theaters economic viability (Lowe,1983). Historically, revenue from concessions, which can account for approximately a third oftotal exhibitor revenues (Vogel, 2011), has been unsuccessfully targeted by producers anddistributors alike, but over time has come to be considered sacrosanct for the exhibitor (Ulin,2010). This reliance on concession revenue drives theater owners to be almost single-mindedlyfocused on traffic (Ulin, 2010). Table 2 Major theatrical exhibition chains Circuit Screens Sites Average Regal Entertainment Group 6777 548 12.4 AMC Entertainment. Inc. 5336 378 14.1 Cinemark USA, Inc. 3825 293 13.1 Carmike Cinemas, Inc. 2268 242 9.4 Cineplex Entertainment LP 1347 130 10.4 Rave Motion Pictures 936 62 15.1 Marcus Theatres Corp. 668 54 12.4 Hollywood Theaters 546 49 11.1 National Amusements 450 34 13.2 Harkins Theatres 429 30 14.3 Other 16,651 4,122 4.0 Total 39,233 5,942 6.6 Source: NATO, as of June 24, 2010 Table 2 shows that the top six domestic theater chains control 52.2% of all screens and27.8% of all theater sites (NATO, 2010), however, due to their tendency to control the bestlocations and most modern screens, the top one third of all screens account for an estimated 75%of domestic theatrical revenue while the top six exhibitors account for at least 80% of the totaldomestic theatrical revenue (Vogel, 2011). 24

34. DREAMWORKS ANIMATION SKG DISTRIBUTION Sequencing and Windowing Profit Maximizing and Shifts Distribution is the art of maximizing profit by choreographing exhibition rights throughsequencing and windowing against the challenge of waiting for the consumptive verdict on theexperienced good (Ulin, 2010). The ability to maximize the return on the whole assumes onedistributor enjoys autonomous control of all distribution rights to set sequencing and windows(Ulin, 2010). As a general principle, films are normally distributed to the market generating the highestmarginal revenue over the least amount of time and then cascading down in order of marginalrevenue contribution (Vogel, 2011). However, distributors are not necessarily looking tomaximize the revenues for each particular exhibition method, but rather to maximize revenuesoverall (Vogel, 2011), so considerations such as the extent to which one exhibition method addsto the total audience or eliminates consumers from other exhibition methods and the rate ofdeclining viewer interest are factored (Owen and Wildman, 1992). As an example of onerevenue source diminishing while overall revenues increase, television networks have abandonedthe practice of aggressive bidding for films with the rise of cable television, which tend to paymore than network television (Vogel, 2011). For the most part, the greatest marginal revenue perunit time is generated from the theatrical release, which also tends to generate the greatestamount of interest in subsequent exhibition methods (Vogel, 2011) As an insight to distribution decisions, Ulin (2010) provides Ulins Rule, stating:Content value is optimized by exploiting the factors of 1) time, 2) repeat consumptions, 3) 25

35. DREAMWORKS ANIMATION SKG DISTRIBUTIONexclusivity, and 4) differential pricing in a pattern taking into account external market conditionand the interplay of the factors among each other. An example of the interplay between thesefour factors is the standard practice of driving repeat consumption of the same product bycreating exclusive windows for different exhibition methods at differentiated prices (Ulin, 2010).Ulin (2010) argues Ulins Rule allows distributors to maximize the lifetime value of a singlepiece of intellectual property. The standard sequencing by distributors starts with the theatrical release and is followedby pay-per-view television, packaged media (VHS, DVD, and Blu-ray), video-on-demand, paytelevision (premium cable channels), and network television (Ulin, 2010). However, theincreasing variety of exhibition methods creates more competition between exhibition methodsand drives an acceleration and compression of windows (Ulin, 2010). As a result, every segmentbecomes fearful of cannibalization of revenues from a different segment and the greatest powerof any window becomes exclusivity, a true rarity aside from the initial theatrical release (Ulin,2010). Against the pressure to shift windows, distributors become the arbiter between exhibitorsthrough the control of exhibition rights, including first rights and exclusivity rights (Vogel,2011). This potentially creates great conflict between distributors and exhibitors sincedistributors make sequencing and window decisions centered on maximizing revenue fordistributors vice exhibitors (Vogel, 2011). Among the pressures on windows is the large amount of capital required to produce anddistribute films. Oversized production budgets, high interest rates, and substantial marketingcosts drive distributors to select sequencing and window strategies to bring the largest return tothe distributor over the shortest amount of time, driving earlier openings of all windows in thedesire for faster recoupment (Vogel, 2011). Specifically, As post theatrical markets such as 26

36. DREAMWORKS ANIMATION SKG DISTRIBUTIONpackaged media, pay-per-view, and video-on-demand services are capable of generating highermarginal revenues over a shorter period of time, distributors can significantly decrease the timeto recoup their investments by reducing the period between release windows between thetheatrical and post theatrical markets (Eliashberg, Elberse, and Leenders, 2006), and continuallydid so from 1998 to 2008 as shown in Table 3. This tightening of windows additionally savesmarketing money for the distributor and opens the exhibition earlier to revenue from customerswho would not have gone to the theatrical release anyway (Ulin, 2010). However, these shorterexhibition windows in theaters has a disproportionate negative impact on theater owners underthe traditional sliding percentage agreement since theaters reap more benefit the longer a filmplays (Ulin, 2010). Table 3 Shrinking Window Between Theatrical Release and Post- Theatrical Release Year Average Time Between Release Windows Days 1998 5 months, 22 days 172 1999 5 months, 18 days 168 2000 5 months, 16 days 166 2001 5 months, 12 days 162 2002 5 months, 8 days 158 2003 4 months, 27 days 147 2004 4 months, 20 days 140 2005 4 months, 18 days 138 2006 4 months, 11 days 131 2007 4 months, 19 days 139 2008 4 months, 10 days 130 Source: NATO memo, December 12, 2008, RE: Average Video Announcement and Video Release Windows, from Ulin (2010) Some support an even more aggressive collapsing of windows into the post theatricalmarket. Stating distributors are simply not maximizing the profit potential of a film, BTIGResearch analyst Richard Greenfield called for distributors to permanently collapse windows as 27

37. DREAMWORKS ANIMATION SKG DISTRIBUTIONthe new Hollywood business model (Chacksfield, 2012), asserting distributors should bepushing the release windows to four weeks instead of four months (Gruenwedel, 2012a),undoubtedly to the delight of many exhibitors and to the chagrin of many others. Additionally, the impact of advancing technology on sequencing and windowing cannotbe overstated, particularly advances in distribution and storage, which has lead to the posttheatrical market to eclipse the theatrical market in terms of revenue (Vogel, 2011). In 1986, forthe first time distributors earned more revenue from the post theatrical market than in thetheatrical market and forever changed the fundamental structure and marketing strategies (Vogel,2011). No longer restricted to bulky prints and costly projectors, feature films can now beconsumed on televisions, computers, tablets, handheld gaming devices, smart phones, and evenlarge, high-quality screens in home theaters for enthusiasts aiming to capture the traditionaltheater experience but with added convenience and comfort. Additionally, consumers can accessan impressive array of films from network and cable television, packaged media such as DVDsand Blu-Rays, video-on-demand services, and websites. As Yves Caillaud, Senior VP of WarnerHome Video and Digital Distribution and Chairman of the Digital Entertainment Group-Europe,observed, Consumers really are spoiled by choice (DEGE, 2011). Jim Hedges, CFO of ABC,observed Historically, viewers consumed television on the big three networks when it wasprogrammed by a network executive . . . Today consumers are programming their ownnetworks by using the many options available to them (Ulin, 2010). This unprecedented abundance of viewing options has reshaped the economic structure ofthe film industry as distributors attempt to maximize profits as newer exhibition methodscompete with as well as complement existing methods (Vogel, 2011). There have been more 28

38. DREAMWORKS ANIMATION SKG DISTRIBUTIONwindow shifts in the last 5 years than in the previous 25 years (Ulin, 2010). The challenge fordistributors is to combine new and old exhibition methods as they come into conflict, typicallydone by slowing adoption of new methods as executives struggle to find a balance between theconflicting methods that does not shrink the overall pie (Ulin, 2010). Typically, however,sequencing will shift in favor of technologies that can realize the marginal revenue contributionat the fastest rates (Vogel, 2011). Unquestionably the largest change in recent years, and perhaps in the entire history ofintellectual property distribution, is the advent of digital distribution, allowing users to choosefrom thousands of films, television shows, and other digital content and begin viewingpractically instantly (DEG, 2008b). One-third of homes in the United States stream videos(Gruenwedel, 2012b) and Netflix alone accounts for an eye popping 32.7% of all domesticinternet traffic from 6 to 10 p.m. (Wasserman, 2011). Digital has also encouraged distributors to adopt second screen strategies to providecustomers with opportunities to enjoy their favorite content . . . between a wide range ofproducts than can share content, including televisions, tablets, smart phones, PCs and gamedevices (DEG, 2012a) as, according Thomas Gewecke, president of Warner Bros. DigitalDistribution, consumers expect to have easy access to their content, whenever and whereverthey want (Prange, 2012). Computers accounted for only 45% of Netflix traffic while gamingconsoles, set-top boxes, smart TVs, and mobile devices continue to grow in popularity(Wasserman, 2011). Additionally, research shows most people under 30 already utilize theircomputers and mobile devices as primary sources of consuming content (Ulin, 2010) while aseparate study found that over 25% of video watching occurs away from the TV (Gruenwedel,2012b). 29

39. DREAMWORKS ANIMATION SKG DISTRIBUTION To this end, five of the six major studios (excluding Disney) plus mini-major Lionsgatesupport the digital UltraViolet format, which allows a single household to create an account forsix family members to access their films and TV shows, and later music, books, and other digitalcontent, from retailers, cablers, and streaming services on up to 12 registered devices coveringmost of the hardware on the market (Hollywood studios announce support for UltraVioletformat, 2011). Three streams are possible at a single time and content can be downloaded andtransferred onto physical media, like recordable DVDs, SD cards, and flash memory drives(Graset, 2011). In an effort to balance old exhibition methods against the new without erodingthe overall total, UltraViolet-enabled Blu-Ray discs have been introduced as distributors clearlytry to maintain value in packaged media (Adams and Cryan, 2012). When windows do overlap, the competition between exhibition methods and the drive tosustain consumer interest in a particular film has lead to a wide variety of developments designedto enhance consumer experience as a method to differentiate between overlapping windows.Perhaps the first of these to be widely used has been the special features included in DVDs.Additional and alternate scenes, extended, uncut, or unrated versions, audio commentaries,behind the scenes vignettes, outtakes, gag reels, crew and cast interviews, and more have allbecome standard fare, and all are possibilities that were not available or practical in the theatricalrelease or in preceding home entertainment formats. When the DVD format was launched in1997, the formats superior sound and visual quality were considered its selling point over VHS,but after a short time special features were being hailed by an impressive chorus of homeentertainment industry experts (Arnold, 2000). Buena Vista [now Walt Disney Studios HomeEntertainment] President Bob Chapek stated the DVD format affords us [the opportunity] tomake it an all-new entertainment experience . . . beyond watching the movie. DVD allows you 30

40. DREAMWORKS ANIMATION SKG DISTRIBUTIONto reinvent the product echoed Mike Dunn, Executive VP of Fox Home Entertainment. Consideration for the DVD special features is even worked into the production of the filmitself (Arnold, 2000). Now, there is great cooperation between the video and theatricalproduction departments in getting materials really early, said Marshall Forster, Senior Sales VPfor Columbia TriStar Home Video. And the additional effort put into special features has paid off. Artisan Sales andMarketing President Jeff Fink noted a significant upside in sales compared to what we wouldhave done if the product had been brought out on VHS only, while Craig Kornblau, President ofUniversal Studios Home Video, asserted special features are an absolute requirement to do bignumbers on DVD. By all accounts, special features were successfully utilized as a method tocompliment revenues from theatrical exhibitions. Interestingly, special features also serve as an excellent example to highlight the oppositeside of film distribution competition as well. By 2010, when distributors felt rentals werecarving too much out of DVD and Blu-Ray sales, special features were being removed fromrented media and consumers who went to view the special features were met with a messagestating This disc is intended for rental purposes and only includes the feature film. Own it onBlu-ray or DVD to view these bonus features and complete your movie watching experience(Studios Crippling Netflix Rental Discs, 2010). This example also illustrates the power ofdistributors to favor one exhibition method over another in an effort to maximize their overallprofit, even if at the expense of a specific exhibitors profit. As a final note, pragmatic financial concerns often find their way into distributionsequencing and window decisions, such as when different divisions within the same distributioncompany compete or when quarterly and annual performance reports are due (Ulin, 2010). One 31

41. DREAMWORKS ANIMATION SKG DISTRIBUTIONexample is Paramounts decision to delay the release of Shutter Island to February 2010 insteadof releasing in late 2009 (Waxman, 2011). Since studios book the cost of a film in the year ofrelease, a late December release where the full brunt of the cost is accounted for with littleopportunity available to realize any revenue can wreak havoc from a bookkeeping perspective(Waxman, 2011). Piracy Although a thorough discussion is well outside the scope of this study, piracy can be seena separate window of release (Eliashberg, Elberse, and Leenders, 2006), the essence of which isearlier or at least simultaneous access and lower prices (Ulin, 2010). While the greatestsuccesses of the internet are often tied to free and ubiquitous access to information (Ulin, 2010),the ad hoc watch-for-free-everywhere-now structure of piracy undeniably threatens distributors(Ulin, 2010). The complete size of the problem is debatable. In an oft cited study by the MPAA,Siwek estimates $20.5 billion are lost to the U.S. economy due to film piracy with an additional$37.5 billion lost to music and software (MPAA, 2011a). However, as Raustiala and Sprigman(2012) point out, not all downloads amount to lost revenue, especially in instances where thepirated copy would not have been purchased anyway. Additionally, Sanchez (2012) widelycriticizes the methodology Siwek uses and references a study specifically performed by L.E.K.Consulting for the MPAA which estimates losses from piracy at $6.1 billion, the majority ofwhich was copied DVDs with $2.3 billion attributed to the internet going as far back as 2005(Ulin, 2010). However, in a comprehensive study of how piracy impacts are estimated, the U.S. 32

42. DREAMWORKS ANIMATION SKG DISTRIBUTIONGovernment Accountability Office determined that the economy wide impact of counterfeitingand piracy on the film industry is unknown (United States Government Accountability Office,2010). However, although the exact extent of the problem is difficult to determine, nonethelessthe U.S. Government Accountability Office study concluded piracy is a sizeable problem,which affects consumer behavior and firms incentives to innovate. Even absent fully reliablestatistics on illegal downloads versus legal purchases, most agree legal watching is simply afraction of overall internet viewing (Ulin, 2010). The Pirate Bay, only one of many such sites, isthe 76th most trafficked website in the world (MPAA, 2011b) and a 2011 study estimates anamazing 23.8% of all non-pornographic internet traffic was related to copyright infringement(Envisional, 2011). Regardless of the exact size, however, the impact of piracy can be seen in the distributiondecisions surrounding sequencing and windows. Simultaneous global release is often used tothwart unauthorized copying (Vogel, 2011) and online piracy is considered as the largest threatto legitimate digital distribution (Cooper, 2012). Customer as Ultimate Arbiter Ultimately, however, the sequencing and windowing of exhibition methods is up to theconsumer, who will determine which exhibition methods survive and whether entertainmentrevenues will expand or contract (Ulin, 2010). In discussing the balance between DVD sales andonline adoption, DreamWorks Animation CEO Katzenberg cautioned We must not undercutour bread and butter [the consumer] . . . The consumer decided when the VHS was obsolete . . . 33

43. DREAMWORKS ANIMATION SKG DISTRIBUTIONNot the hardware manufacturers, not retail, not us (Ulin, 2010). Key Markets Domestic Theatrical Market Initial performance of the domestic theatrical release overshadows and largely determinessuccess in all subsequent markets, both in terms of what the film can command from posttheatrical exhibitors (Vogel, 2011) and also due to the media attention surrounding theatricalreleases that drive awareness that can be amortized over the life of the film and can driveconsumption for months and even years (Ulin, 2010). As one industry insider described,Theatrical exhibition is the major factor in persuading the public what they want to see, even ifthat public never sets foot in a motion picture theater. And how well and how long a pictureplays in theaters has everything to do with its value in other markets (Daniels, Leedy, and Sills,1988) due to a combination of advertising, media attention, and word-of-mouth (Eliashberg,Elberse, and Leenders, 2006). In more muted language perhaps suitable for public filings,DreamWorks Animation (2012b) recognizes that films that achieve success in the domestictheatrical release tend to experience success in the home entertainment and internationaltheatrical markets, although still simultaneously cautioning investors that domestic theatricalperformance is not the only factor influencing a films success in subsequent markets. However,it is typical that a film deemed a theatrical failure is a failure, but a film deemed a theatricalsuccess is a cascade of success (August, 2011). Strangely, the domestic theatrical release has remained as relevant as ever, if not 34

44. DREAMWORKS ANIMATION SKG DISTRIBUTIONincreasingly so. In other industries, traditional outlets are typically overtaken by newer channelsof distribution and the traditional outlet dwindles in importance and may even vanish entirely(Ulin, 2010). In the film industry, however, the domestic theatrical release has become evenmore important to the success of a film in later distribution channels (Ulin, 2010). However, in spite of its importance, a theatrical release will seldom recoup theinvestment in a film and can be properly seen as a loss leader that creates awareness of the filmfor subsequent windows (Ulin, 2010). Approximately 80% of films do not recover even printingand advertising costs during the domestic theatrical release (Friedman, 2004). Most distributorsare reconciled to lose money at this stage and are not necessarily deciding to pull the film off thebasis of continued theatrical revenue but rather on the opportunity costs of not showing otherfilms combined with continued marketing costs (Ulin, 2010). As an example, in 2004 the six major studios combined for a $2.2 billion loss on $7.4billion in domestic theatrical revenues, spending $1.30 in expenses for every dollar in revenue(Epstein, 2005). However, considering the domestic theatrical release is but the first triggeramong release windows (Ulin, 2010) and domestic theatrical revenue is but simply the revenuefrom domestic theatrical exhibitions (Ulin, 2010), the post theatrical market has become theprimary source of profit (Vogel, 2011). Again using 2004 as an example, DVDs brought a profitof $13.95 billion from $20.9 billion in revenue and television realized a $15.9 billion profit from$17.7 billion in revenue, for a total profit of $27.65 billion from the 59.5 billion in revenueamong the six major studios from domestic theatrical, DVD, and television markets combined(Epstein, 2005). As important as the domestic theatrical release is, the performance of a film is difficult topredict because of each films uniqueness and the complex and dynamic environment it enters 35

45. DREAMWORKS ANIMATION SKG DISTRIBUTIONinto (Vogel, 2011). William Goldman, Oscar-winning screenwriter, famously described thecorrelation between a developed idea and commercial success as Nobody knows anything(Ulin, 2010). As such, a films initial value as part of the distributors portfolio is grounded insubjectivity (Ulin, 2010). However, certain external factors do tend to influence performance, such as ticket prices,running times, season, weather, the number and quality of theaters, number of seats, andcompeting releases (Vogel, 2011). The only overwhelming predictor of a films success is thenumber of screens it plays on (Elberse and Eliashberg, 2003), placing distributors in a position tocourt exhibitors for the valuable resource through the convincing use of marketing and well-known movie stars and directors (Ulin, 2010). Of the domestic theatrical release window, the opening weekend is largely the barometerfor judging a films success and the release is typically the most heavily marketed (Ulin, 2010).Given the importance of a strong domestic theatrical performance, a successful opening weekendcan fuel downstream markets that generate revenues for years (Ulin, 2010). In general, drop off from the opening weekend is approximately 50% and a film thatdrops off significantly more than expected, such as 60% to 70%, may be perceived to have notbeen well received and can be in trouble (Ulin, 2010). This opening weekend decay patternresults in distributors crafting aggressive marketing campaigns for what is essentially is a filmsone shot at a successful release (Vogel, 2011). However, the bigger the opening week thesteeper the decay will likely be upfront (Ulin, 2010). Additionally, a more sophisticated decaymay be built utilizing other factors such as holiday weekends, but nonetheless week to weekperformance is still measured as the deviation from the expected decay (Ulin, 2010). Unfortunately for an underperforming film, screens will be allocated to other films, 36

46. DREAMWORKS ANIMATION SKG DISTRIBUTIONmaking a second weekend rebound a rarity (Ulin, 2010). Compounding the issue is that aftertens of millions have been spent to convey a specific marketing message to audiences, it isvirtually impossible to recover after a weak opening, both because of the compromised messageand because the distributor will mostly likely prefer to spend valuable marketing money on filmsstill considered viable (Friedman, 2004). Compiling information from The Numbers, of the 137 films initially released on or afterJanuary 1, 1995 that grossed over $200 million domestically in adjusted dollars, $9.9 billion ofthe $39.8 billion grossed in total came on opening weekends, or 24.9% of a films total domesticrevenue. Family films showed virtually the same pattern, grossing $2.8 billion out of $11.7billion on opening weekends, or 24.2%. However, this trend appears to be creeping upward, aseven large films are tending to have only one or two weeks of strong theatrical performance asopposed to more evenly distributed performance over longer weeks as was previouslyexperienced (Vogel, 2011). Of the 27 films initially released in 2009 to 2011 that grossed over$200 million domestically adjusted dollars, $2.3 billion of $8.0 billion (28.2%) in total domesticrevenue was realized on opening weekend. Of the 7 films that met this criterion in 2011, $676million out of $1,869 million came on opening weekend, or 36.2%. As a result, selecting release dates for films has become critical, partially because of thefilms opening weekend revenue and also because financial agreements with theaters give thedistributors a greater percentage of the revenue during the first weeks of release (Trying toenhance new films prospects, 1991). Barry Reardon, President of Distribution at WarnerBrothers, cautions If you dont pick the right release date, you can destroy a movie (Trying toenhance new films prospects, 1991). DreamWorks Animation (2012b) considers thescheduling of optimal release dates as critical to success. 37

47. DREAMWORKS ANIMATION SKG DISTRIBUTION There are a number of outside factors than can impact a films release date, which caneither be programmed in advance, such as the Olympics or national elections, or news events,such as wars or natural disasters (Ulin, 2010). Additionally, these outside factors offer additionalcompetition for precious media space as well, making it more difficult and expensive to market afilm that consumers have an increased chance of opting out of anyway (Ulin, 2010). Distributors can also improve a films chances by selecting a release date during a peakweekend or peak season. Using data from 1969 to 1984, Murphy (1984) identified eight peakweekends for domestic theater attendance: Presidents Day, Easter, Memorial Day,Independence Day, Midsummer, Labor Day, Thanksgiving, and Christmas/New Years and Einav(2007) found essentially the same results using data from 1985 to 1999. Memorial Day,Independence Day, Thanksgiving, and Christmas weekends have been identified as prime realestate (Ulin, 2010) with the summer being the peak season, where from 1983 to 1992 between35% and 41% of the entire years revenue occurred during the summer months, averaging 37.8%(Vogel, 2011). This concept is generally extended into the international market, although thepeak dates can vary from country to country due to different holidays, school schedules, andother competing activities (Vogel, 2011). However, peak weekends are no secret to distributors and now a film with two or threerelatively clear weeks is rare (Ulin, 2010). Competition from within the film industry originatesfrom three sources: 1) competition from films being release from the same distributor, 2)competition from films targeting the same demographic or in the same genre, and 3) genericcompetition from other films being released (Ulin, 2010). As a result, distributors arecontinuously evaluating competitor films that open immediately before, during, and immediatelyafter a release (Ulin, 2010). DreamWorks Animation (2012b) pays particular attention to 38

48. DREAMWORKS ANIMATION SKG DISTRIBUTIONexpected release dates of other films produced by other animation studios, although attention ispaid to expected release dates of live-action and other event films vying for the same broadaudience appeal. In part cooperative and part competitive behavior, studios claim release datesearly to ward off potential competitors by commonly mapping out peak weekends years inadvance (Ulin, 2010). For example, the date for Harry Potter and the Sorcerers Stone wasadvertised three years in advance (Fellman, 2004). Distributors face an interesting strugglebetween attempting to capture as much revenue as possible during peak release periods whilesimultaneously avoiding competition for audiences (Krider and Weinberg, 1998). In the midst ofmultiple event films during the summer of 1995, film executives explained the unexpectedlyoverall weak domestic theatrical performance as the failure to properly de-conflict popular films,as too many expensive movies stacked too close together at the beginning of the season . . .[resulted in] one big movie [being] cannibalized by the next one (For movies, its the dogdays, 1995). At least one interesting example of competition for release dates involved DreamWorksAnimation and Pixar. In 1994, Pixars Creative Chief John Lassiter pitched the idea for an ant-themed film to Disney executives, which at the time included Jeffrey Katzenberg (Fleeman,1998). Katzenberg left Disney soon after and co-founded DreamWorks SKG with directorSteven Spielberg and record executive David Geffen (DreamWorks SKG Studios, n.d.) and,coincidentally or not, almost immediately began work on another ant-themed film appropriatelylabeled Antz (Burrows, 1998a). When Pixars A Bugs Life was scheduled to open on November25, 1998, directly opposite of DreamWorks Animation traditionally animated Prince of Egypt,Katzenberg reportedly offered to cancel the development of Antz if Pixar would agree to movethe release date of A Bugs Life. When Steve Jobs, then-CEO of Pixar, declined (Burrows, 39

49. DREAMWORKS ANIMATION SKG DISTRIBUTION1998b), Kat