Reflections on the Fate of the Independent Exhibitor

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Wed, 08/26/2009 - 20:00 -- Nick Dager

Reflections on the Fate of the Independent Exhibitor By G. Kendrick Macdowell Vice President General Counsel Director of Government Affairs National Association of Theatre Owners As the industry undergoes the most transformative revolution since the talkies film perforations give way to binary digits.  A relatively simple and competent 100-year-old technology surrenders to expensive computerized projection. There are clear benefits to be sure but exhibitors have been conflicted. Nowhere is the conflict more pronounced than among the small-town few-screen operators who have anchored the movie industry in countless communities across North America.  Independent theatre operators have been performing an essential and valuable service for the movie industry for generations and they’ve been doing fine.  The margins may not have been great but these are people with a passion for showing movies creating a culture of movie consumption and becoming cultural bastions in their communities.  That has been reward enough. The digital transition is a strange expectation.  Even the best-case scenarios currently proffered for independents—for full-time first-run theatres—compel many thousands of dollars in site modifications a $10 000 and upwards exhibitor contribution per screen before anything happens up to $6 500 per screen installation costs thousands of dollars more than existing film systems in annual maintenance costs steep fees and costs for alternative content and 3D capability (the “promise of digital”) and myriad additional fees and costs not yet realized. For the many hundreds of theatres who are not full-time first-run the current numbers are ghastly and guaranteed to eliminate any of these independent operators who do not have access to loads of cash.  The current paradigms—among integrators studios and exhibitors—simply do not account for what kind of industry we want to look like on the other side of the digital transition.    Box office gross and the arguably more arbitrary “VPF-earning potential”—how fast exhibitors can churn studio titles—may not reflect the value to the industry of independents. VPF-earning potential in particular has become an albatross that threatens to unravel the exhibition industry and do permanent damage to the consumption of movies in North America.  That is because studios desired a middleman—an integrator—for reasons that seemed salutary but beget an entity that focuses solely on revenue from the most number of movies turned.  Such an integrator in the case of exhibitor-owned DCIP can look to the interests of its owners as well as or more than itself.  Such an integrator in the case of any integrator available to independents across North America will naturally look first to its own interests. That is not to say there has not been some creative thinking by studios.  Indeed great credit for example to Julian Levin at Fox Jason Brenek at Disney and Mark Christiansen at Paramount for coming up with some of the best ideas for working toward a fair digital transition for independents. But independent exhibitors across North America are in a pinch.  The casualties are mounting.  Hundreds of independent exhibitors have already elected not to try to convert to digital.  Many of our CBG members who thought they could make a go of it have since dropped out.  What remains is a core of passionate and committed independent exhibitors the best and the brightest who contribute so significantly to our continental culture of movies in ways that cannot be captured simply by box office gross and VPF-earning potential. Never in the history of this industry has one group of exhibitors represented such a critical mission for the heart and soul of exhibition—and ultimately the movie industry.  At stake is yes the heart and soul of the industry but in many communities likewise the only likeable face of popular entertainment the single place where the magic of movies is local and personal and creative. The big circuits brilliantly deliver the movies the mass of people want to see so that North Americans truly have a national culture and conversation.  But it is the independents who bring texture and depth and local color to the business of showing movies.  And they bring movies to so many people would not know or care about movies on the big screen or elsewhere otherwise. It is the independents struggling to get product who feature idiosyncratic slates of movies that unite on the big screen moviemakers and patrons who would never otherwise meet in a world driven entirely by commercial viability. It is the independents with their keen attention to the community and its homecomings local histories proms and parades who make the movie theater a place of local pride. It is the independents driven by economic necessity and unable to take any patron for granted who develop creative promotions and local tie-ins for the movies they manage to get. It is the independents who solve a disruptive patron problem by calling the parents whom the owner knows personally. It is the independents who enforce the rating system with remarkable vigilance and honor—because it is the right thing to do—in conspicuous contrast to the abysmal ratings enforcement of small DVD outlets and grocery stores. What has been said of Ginger Rogers vis-à-vis Fred Astaire—she  did it all dancing backwards and in high heels—might be said of independents vis-à-vis the circuits. The industry needs both—independents and circuits.  It is a synergy that serves the larger movie industry so well.  Every CEO of America’s largest circuits is honorably on record emphasizing the importance of independent exhibitors to the strength and diversity of American movie-going culture.  NATO’s chairman Lee Roy Mitchell himself an independent in his early days puts it well: “Small-town America goes to movies because of independents.  Many of these people move to big towns and they continue to be avid movie-goers in our theatres because of independents.”  It’s a cross-dependence of encouraging movie consumption.  And it is a perilous path to let these independents die on the digital vine. This paper urges solicitude for these independents. I. Who Are the CBG Exhibitors? By far the majority of CBG members are full-time first-run exhibitors.  They fit into current models for financing digital cinema. We define full-time first-run as exhibitors who generally play a movie within one or two weeks of the national break.  We cannot be absolutely certain about these numbers.  We provided the definitions but we believe some of our members responded to our survey thinking they were first-run because they were the first in their communities to exhibit the movie or because no one else was showing the movie. So the numbers could shift—but we do not believe the shift would be significant and we’re especially comfortable with the proposition that digital cinema could easily convert many of these thought-we-were-first-run cinemas to genuine first-run cinemas because digital cinema facilitates precisely that kind of distribution flexibility for studios. As of April 2009 there were 554 CBG members in the United States and Canada running a total of 6 680 screens. In addition there are 32 CBG members with 826 screens who have either opted out of participating in the CBG digital arrangement or who have not provided sufficient information to be eligible for participation. While most CBG members fit comfortably into current paradigms for digital financing some critical members do not.  These are segments of the industry that the industry can ill-afford to lose—exhibitors playing three or four or five weeks off the break in communities that do not have any other theatre within 50 miles art house or special venue theatres that bring adults who had stopped going to the movies back to the movies drive-in theatres that serve a unique niche in American culture discount and dollar houses that make big-screen movies accessible to so many Americans who could not afford movies at all but for these venues. These are niches—not so many in the scheme of things but vital to the North American culture of movie consumption. II. Why Do CBG Exhibitors Matter? First as Lee Roy Mitchell recognized above independents create a culture of movie-consumption that would not otherwise exist.  Says the owner of Visulite Cinemas in Staunton Virginia:  “Our special events draw big crowds that might not ever go to movies and lend excitement and ‘event’ status to films that appeal to grown-ups many of whom had stopped going to the movies.”  Arlington Cinema & Drafthouse with its restaurant and cinema model says “simply put we bring people back to the movies that stopped going or stopped going frequently.” By making going to the movies something a little different independents across North America maintain and often reignite a culture of movie-going. This culture of movie consumption plays out in ancillary markets in a big way.  As Visulite Cinemas in Staunton Virginia describes “one of the most popular local video stores now stocks all of the films we show (foreign domestic major minor) adding another profit stream that did not exist before our opening.”  Many other members describe a similar synergy. Second creating a culture of movie-going is one thing but even more fundamental is the role of independents in bringing movies to patrons who would not be consumers otherwise.  The great majority of CBG members operate in regions without another competitive theatre anywhere near.  In short CBG members constitute the only avenue to movies on the big screen—and thus appreciation of movies generally—for many thousands of North Americans. Within the CBG membership 1008 theatre locations with 5 638 screens are in free booking zones.  Of these 211 locations with 477 screens are not full-time first-run theatres. If a critical mass of these theatres shut down (and some have already reconciled to doing so because of the exorbitant cost of digital conversion) many communities will no longer have a movie theatre.    Having a DVD outlet is not a wash.  Movie theatres create interest in and demand for movies. Consuming movies is an acquired habit most palpably formed at a movie theatre.  A community without a movie theatre is a community that consigns movies to the status of video games YouTube videos and TV mini-series—just another small-screen entertainment option among many. Of course as many of our members in competitive zones rightly insist they serve the salutary purpose of maintaining a price and quality check on their larger competitors.  So whether independents are in free-booking or competitive zones the industry is well-served. Third CBG members create incalculable good will in their communities.   Hollywood as a cultural phenomenon engenders fascination and revulsion.  And as a political base its geographical reach is tiny.  But the many hundreds of exhibitors who make the products of Hollywood available to millions of North Americans conspicuously soften the edges of Hollywood in their own communities.  CBG members are small businesses typically with a high profile and big hearts who make Hollywood look better than it would without them. This community profile cannot be captured in box office gross or VPF earning potential—but it is a value that Hollywood dismisses at its peril.    In the aftermath of Columbine when the industry was compelled to spend hundreds of thousands of dollars fighting off heavy-handed government regulation of movies access to members of Congress was at a premium.  One very significant Senator in the mix Trent Lott of Mississippi listened to the industry because a small-town theatre owner who knew everybody’s name— where Senator Lott had attended movies as a boy—had his ear.  Bean counters can’t count this. Fourth CBG members as small businesses are driven to attract and keep patrons.  Most exhibitors large circuits and independents alike engage in creative marketing.  But for independents creative marketing and carefully cultivated community relations can often dictate survival in a market.  Most especially for independents playing off the break after studio ad campaigns have faded creative marketing is essential. The studios’ top-down marketing generates great buzz for imminent box office hits with star power.  For other movies or movies played off the break CBG members employ a range of inventive marketing tools to mobilize moviegoers at little to no expense to studios.  Independent exhibitors leverage their intimate knowledge of their market demographic local partnerships that facilitate cross-advertising and their administrative flexibility to be as imaginative as possible.    In sum nobody in this industry with any history in it would view the decline of independents with other than alarm.  Independents constitute a special case—a reason for studios and integrators to think long-term about the character of the industry and to show special solicitude for CBG-specific digital financing arrangements.  Our subset of independents—dues-paying CBG members in good standing—have especially demonstrated the fortitude and passion for this industry to warrant the kind of creative thinking urged herein. III. Some Ideas (Not an Exhaustive List) To Make Digital Cinema Work for Independents and the Industry. The bulk of the thinking about financing the digital cinema transition has occurred with reference to a single dynamic of the movie industry: film print volume.  Perhaps because the model got fixed with the label “virtual print fee” early on and then entailed a middle for-profit entity to administer the financing and implementation “prints” and “print costs” became fixtures in the digital cost accounting—notwithstanding studio savings into the indefinite future.  The “print cost” fixation is understandable.  While agreeing to contribute to the financing of digital cinema for obvious reasons studios equally obviously wish to avoid short-term cost spikes that look troubling on the books and thus aim to calibrate as possible financing contributions to what would have been costs anyway. By fixing the digital financing model to print costs however the industry imperils a substantial swath of exhibition that has not historically “cost” distributors in print costs.  For the reasons set forth above it is short-sighted to penalize exhibitors who have not historically cost distributors—but have generated box office revenues or otherwise contributed to the strength of the movie industry in North America. It is not our aim to seek a naked subsidy for cinemas simply because they are small—but to urge a second look at the unfairness of a model that would arbitrarily consign many small cinemas however robust and vital in their communities to oblivion simply because studios had not historically spent much in print costs. Moreover it is not our aim to produce commitments applicable to the industry at large.  CBG members constitute a special and vital subset of the exhibition community and CBG-specific accommodations make perfect sense.  We undertook a wide-ranging and high-profile membership recruitment effort lasting nearly two years.  In many forums we warned exhibitors—to the point of becoming vexatious—that they declined to join CBG or otherwise make provision for the digital transition at their peril.  Many independent exhibitors elected not to join or have since dropped out.  The CBG members who remain have paid annual dues and remain passionately committed to the future and to showing digital movies in their communities.  It is therefore entirely appropriate to execute a CBG-specific addendum to any more general agreement with an integrator.  We believe the stakes for the industry fully justify a special solicitude for independents who have demonstrated their commitment by sticking with the CBG through anxious times. The following list of ideas aims to adjust the prevailing paradigm though few ideas depart significantly from current models.  We are indebted to creative thinkers in studios for many of these ideas and we gratefully acknowledge the good will of our distributor partners in seeking ways to make this revolution happen without convulsing and diminishing the independent exhibition industry. A. Exhibitor-Financed Systems It’s an idea born in the rubble of the credit markets.  The substantial sums needed by any integrator or DCIP for a full roll-out of thousands of screens are simply unavailable at this time.  But what if individual exhibitors had banking relationships and could obtain financing just for themselves?  Might that expedite the roll-out for these exhibitors (and perhaps helpfully reduce the total credit sought by an integrator)? If the studios agree to allow exhibitors to purchase their own digital systems and pay VPFs to reimburse these exhibitors for the system cost then... Exhibitors could purchase systems at negotiated volume pricing for CBG members;   An integrator would collect agreed-upon VPFs from the studios and pass them through to participating exhibitors in all categories; The integrator would manage and administer studio requirements including for example DCI compliance log data missed shows and other reporting; and the integrator would collect a management/administrative fee to be determined. With the big roll-out stalled along with the economy some small roll-outs could move along the digital transition for some (and thus the availability for example of sufficient 3D screens) and ease the credit burden for the balance of the industry. Similarly some equipment manufacturers have indicated a willingness to extend financing terms to exhibitors—which would make exhibitor-financed equipment an option for more CBG members.  While we do not anticipate a large number of CBG members able to self-finance we have heard urgent support for the concept among a few. B. Post-Recoupment VPF Payments Critical to the funding of digital cinema for CBG members—especially those exhibitors who would not qualify for full VPF payments under current models—is the creation of some pool of money beyond recoupment of the integrator’s cost of the equipment.  A recoupment-only model does not work for CBG members.  Assume the financing term is ten years.  If studios refuse to pay VPFs beyond the point where the cost of equipment at a location is recouped then for many locations VPF payments cease after six seven eight or nine years.  If on the other hand studios agree to pay VPFs for the duration of the financing term—mindful that some locations will recoup before the ten-year period and some locations will never recoup—then at least some pool of funds becomes available to assist locations without robust VPF-earning potential. For studios post-recoupment VPF payments pose no short-term cost-spike because the same payments simply continue longer than they would have as to some locations.  For exhibitors post-recoupment payments do not ask any exhibitor to subsidize another exhibitor merely because that exhibitor has a higher VPF-earning capacity. Such post-recoupment payments would create a fund of additional money that could be used to lower the cost of equipment for CBG members that are more difficult to finance (i.e. other than full-time first-run theatres). We invite further thinking on how this fund of post-recoupment payments could best be employed to make equipment accessible to small exhibitors.  The only model proffered to date would entail a “rebate”—at the end of the financing term—to exhibitors who were obliged to contribute crippling sums up front.  While the ten-years-away rebate could be substantial depending on the aggregate timing of recoupment an enormous up-front cost is simply beyond the means of many small exhibitors. C. VPFs for 7+ Weeks Off the Break Consistent with the philosophy outlined above—calibrating VPF payments to present print costs—studios have resisted VPF payments to exhibitors playing movies seven or more weeks off the break.  Agreeing to contribute some VPF payment in such circumstances—mindful that sub-runs occupy an important niche in movie-going and contribute perhaps more directly to consumption in ancillary markets—would help to offset the otherwise crippling up-front exhibitor contribution for these locations. D. Weekly VPF Payments for Subruns Perhaps the most problematic aspect of the print-cost calibration model is its devastating effect on our members who do not play most of their movies on the break.  The discounted VPF payment after the second week is so deep that such exhibitors are obliged under current proposals to pay up-front costs that are simply beyond any conceivable means of many if not most such exhibitors.  CBG proposes that for non-Class-A theatres only studios would pay one- third of a full VPF for each up to three that the exhibitor shows the movie.  Thus for example a three-week engagement would generate a full VPF payment.  The exhibitor would thus be incentivized to carry the movie for a longer engagement and the distributor would be incentivized to move such an exhibitor closer to the break to maximize box office gross without incurring any additional VPF payment based upon the two-week demarcation in VPF payment size.  Win-win. E. Moving Onto or Closer to the Break Digital holds out the promise of easing studio constraints on the timing of distribution.  It is significantly more costly to make prints available to small-town theatres for example than to distribute a digital version.  Not surprisingly our members report their certainty that they could increase their gross by 50 to 100 percent by playing the same movie on the break that they currently play a few weeks out.  Whether the current model adequately facilitates such an acceleration is unclear.  CBG requests a good-faith review of all non-Class-A theatres with a view toward providing more bookings on or closer to the break.  We invite further thinking on how an accelerated distribution for CBG members might work and/or be relevant to the financing. F. Grandfathering Previously Deployed Systems What once appeared relatively incidental in the scheme of things now looms larger as the credit markets further delay large-scale deployment—and indeed even foreclose reliable prediction as to when deployment might be viable.  (Indeed even optimistic predictions of credit availability foresee it coming in tranches rather than all at once.  Thus any individual exhibitor even if capable of predicting when some credit might be available would not be capable of predicting its availability to him.)  Responding to studio urgency to acquire 3D capability on the one hand and to competition with already-deployed digital screens on the other hand some exhibitors are compelled to convert some portion of their screens to digital on their own.  We believe the allowance for grandfathering in such circumstances should be generous.    Moreover we see no justification for reimbursing exhibitors only at depreciated rather than full value (subject of course to a total system cost cap and the exhibitor contribution level).  Exhibitors who are obliged to acquire some digital capability now obviously can neither control the timing of the credit markets nor base their business decisions on any reliable prediction of when full-scale deployment would be possible.  Moreover given the general obligation to convert an entire location with a single integrator’s equipment an exhibitor with some previously-deployed equipment who wishes to convert the balance of the location has no choice but to be grandfathered.  They should not be penalized by depreciated reimbursement.  CBG proposes that CBG members be reimbursed at 100 percent of their cost (up to the maximum system cost). G. Reducing Costs and Fees We are exploring ways to bring down equipment costs where locations warrant.  While there is not yet much latitude here some ideas such as eliminating the theatre-management system for fewer than five screens or using lower-cost projectors on smaller screens are worth exploring further.  While studios may have little to contribute here (apart from resisting the temptation to add further complexity and thus cost to equipment or perhaps relaxing DCI rigors in some markets to allow for significantly lower-cost equipment such as reducing the 5.1 audio requirement for smaller theatres) we invite thinking on ways to reduce costs for theatres confronting above-average up-front costs—for example forgoing screen advertising usage fees for locations that are not full-time first-run. H. New Build Allowance In such an anxious and forbidding economic environment trying to game the system and build multiple new theatres in anticipation of cashing in on digital financing seems a stretch.  We have seen no evidence that any CBG member’s anticipated new builds are other than fully-considered and fair business decisions.  We believe the allowance for new builds should be generous—perhaps with a graduated exhibitor contribution as the new build moves further from the large-scale roll-out.  We believe it imprudent to discourage reasonable development of new markets or reasonable enhancements of existing markets and we certainly do not want independents competitively disadvantaged vis-à-vis any other exhibitors.  CBG proposes a 15 percent allowance for new builds for the CBG membership. I. Extended Print Availability Our members have already voiced concern about the shrinkage of print availability.  The concern is most pronounced not surprisingly for members operating in or near markets of exhibitors who have converted to digital.  We understand the impulse to seize whatever savings on print costs become reasonably available but we ask the studios to consider ensuring some minimal supply of prints for CBG members (without of course suggesting any interference in studios’ discretion to choose their licensees).  Put simply some of our members will not be able to afford digital equipment under any current or conceivable scenario unless equipment costs come down or used equipment becomes available.  Yet some of these members are brilliant exhibitors and their loss in their communities would be profoundly felt.  We anticipate a relatively robust market in used equipment in due course—but that will take time.  Meanwhile the only way for our valuable but undercapitalized exhibitors to weather the transition is to have some assurance of print availability.  CBG proposes as an example of stabilizing the print market for independents that studios make available 500 film prints per title for seven years.  We invite further thinking on how such an idea might play out but we hope studios see the wisdom of extending print availability as a transitional measure. The foregoing is intended to stimulate further creative thinking as there are certainly additional ideas worth considering.  We hope at a minimum that every stakeholder embraces the premise that CBG members as the most dedicated exemplars of the vital community of independent exhibitors warrant some creative solicitude outside the conventional models. (Editor’s Note: This is an edited version of a paper that was first posted in January and can still be found on the NATO website Contact: Kendrick Macdowell Vice President General Counsel and Director of Government Affairs National Association of Theatre Owners 750 First St. NE Suite 1130 Washington D.C.  20002 (202) 962-0054 [email protected]