The Tinseltown Identity: sixty per cent of movies (even with multiple platform distribution) and ninety per cent of TV series lose money.

So what's a studio to do?

Convert it to the Tinseltown Ultimatum:

Ditch the residual payment system .

Movie script writers are entitled only to their initial fee under copyright rules, which of course no one in Hollywood is proposing to touch.

Why should the writers continue to make money as long as the show is popular? Why should the studio continue to make money as long as the show is popular?

Copyright law allows the studio's to continuously make money through a government granted monopoly of the show (aka, copyright). The studios argue that they should be able to keep that monopoly for 90 years+ so they can continue to make money long after they have been paid back for their costs. Since they 1950's, writers and other creative have been able to participate in these profits. This allowed the studios to pay less upfront in lieu of payments based on the future success of the show.

The OP and the FA seem to suggest that residuals are sucking the studios dry when, in fact, they are designed to allow the studio to initially pay less in return for profit participation.

The studios aren't actually talking about eliminating residuals, they are subtler than that, they are just talking about paying them from the net profit:

From The FA:

"Under their proposal, unveiled with unexpected zest in early July by Barry M. Meyer, chief executive of Warner Brothers Entertainment, so-called creative employees w

ould get residual checks only after the studios have recouped their basic costs."

Of course, "net profit" in Hollywood is the profit that is left over after veteran studio accountants have labeled all the profits as expenses. The studios have virtually no intention of every paying off residuals out of net.

This isn't about poor, cash-strapped studios victimized by greedy writers, this is about powerful studios who want to keep the profits for themselves and away from the creative people who worked to make the show successful.

I have not read Harold Vogel's book, but I do know about accounting.

You state that the studios do not intend ever to pay residuals out of net, but they never could, because net by definition is what's left after all expenses, including residuals, are paid and accounted for on the income statement. I assume GAAP rules prevail even in the smoke-filled offices of Hollywood, at least when the FASB looks at the studios' books.

"You state that the studios do not intend ever to pay residuals out of net, but they never could, because net by definition is what's left after all expenses, including residuals, are paid and accounted for on the income statement."

I didn't actually say they would never pay out of net, I said they had "virtually no intention." Movies have traditionally offered above line workers ("important" creative types--writers, directors, leading actors, etc--rather than unlucky grunts) percentage points of a film's profits. These payments can be based on a percentage of gross profits or a percentage of "net." The industry maxim is "never take net" because the studio manages to never have any "net" no matter how profitable the movie is. "Net" profit in these circumstances is Hollywood-style net, obviously, since there are still payments to be made from this "net" profit.

Art Buchwald famously found out how difficult it is to get paid out of net, even for a profitable film.

http://en.wikipedia.org/wiki/Buchwald_v._Paramount

"The decision was important mainly for the court's determination in the penalty phase of the trial that Paramount used "unconscionable" means of determining how much to pay authors. Paramount claimed, and provided accounting evidence to support the claim, that despite the movie's US$350 million in revenues, it had earned no net profit, according to the definition of "net profit" in Buchwald's contract, and hence Buchwald was owed nothing: a classic example of Hollywood accounting."

Unlike net points, which only powerful people are granted and are generally only paid for movies, residuals are part of the standard Writer's Guild contract for both films and television shows. The studios are now proposing to pay residuals for all productions out of net. Writers (I'm neither a writer or a Hollywood insider) are suitably dismayed. They know to never take net points and they know that they are unlikely to ever earn "net residuals."

errata: That last paragraph should start;

"Unlike points..."

Nobody with real power takes net points. They all get gross points.

Correct me if I'm mistaken, but my recollection of the discussion of the Paramount case in Against Intellectual Monopoly is that it was wrongly decided and that Buchwald's suit had no merit.

From the Wikipedia article you cite:

Hollywood accounting has long been derided as a cynical attempt by movie studios to cheat individual authors out of royalty payments. The accounting formulas used by the studios have allegedly been designed specifically to ensure that it is almost mathematically impossible for any movie to show a net profit. Specifically, the net profit formula in authors' contracts does not correspond to the net profit formula of generally accepted accounting principles that the movie studios use when creating their financial statements that are reported to the U.S. Securities and Exchange Commission and to the investing public. The "unconscionable" formula in the authors' contracts effectively double-counts many costs borne by the movie studio.

If this is true, why are the authors allowing it to happen? Don't they have accountants and lawyers?

If residuals are wages, then clearly they are operating expenses and would be subtracted from a firm's gross margin to yield its operating income. It they are bonuses, they would still be accounted for this way, just like any other bonuses, such as those paid to salespersons, traders on Wall Street, etc. Paying residuals out of net income is effectively making those eligible to receive these equity participants, which is how some actors earn money, in addition to their fee.

"Correct me if I'm mistaken, but my recollection of the discussion of the Paramount case in Against Intellectual Monopoly is that it was wrongly decided and that Buchwald's suit had no m"

I don't remember the details off hand, but IIRC much of that sentiment was based on the idea that Buchwald was hopelessly naive in expecting that a movie that made $350 Million dollars would ever pay net points, that he should have known better for taking net points and that everyone knows that net points are worthless. It was more a defense of the status quo rather than a defense of Hollywood accounting being fair and reasonable.

"If residuals are wages, then clearly they are operating expenses and would be subtracted from a firm's gross margin to yield its operating income."

I think you are really concentrating too much on the standard accounting definition of "net." Net, in Hollywood parlance, is a term of art defined by contract. It is distinct and separate from the standard accounting term.

"If this is true, why are the authors allowing it to happen? Don't they have accountants and lawyers?"

Why do people "allow" companies to raid pension funds? This isn't a perfect world. Studios have the money. Everyone else is a beggar not a chooser, except to the extent their star power or union can negotiate a better deal.

If I recall the argument about Buchwald, he claimed he "owned" the idea that was used to make the movie and that he was legally due as an owner, citing a copyright claim. If my memory is correct, he had no valid legal claim to begin with, and the suit should have been laughed out of court. All the stuff about net points is beside the point; he was owned nothing.

If I describe an idea for a film to a producer, or write a precis for it that he sees without actually pilfering it from my property, and he "goes behind my back" by hiring a screenwriter to produce a script, which later becomes a movie, I am owned nothing, not even a credit. Substitute Buchwald for me, and I think this is what Paramount was about, or maybe my memory is really foggy.

The reason I am trying to hone in on the accounting is that I am trying to understand Hollywood accouting and where it might go off track (without having read Vogel's book, this might be an exercise in futility--like ignorance would ever stop me). Net should be defined by accounting rules, not by contract. Also, why can't the relevant parties demand up front payments--sans residuals--that are more or less equal in PV to what they'd get with residuals? They should also realize that equity participation in the real world comes with both upside profit potential and downside risk (i.e., loss) that mere wage earners don't have. Then back to the accountants and lawyers on this. Thinking about the last point this morning, it dawned on me that Hollywood lawyers and accountants are taking advantage of their clients' ignorance to rip them off--and it couldn't happen to a more deserving and copyright-mollycoddled group.

"Also, why can't the relevant parties demand up front payments--sans residuals--that are more or less equal in PV to what they'd get with residuals? "

Because you don't know how successful a show is going to be in advance. I'd say that residuals are a form of profit participation/shared risk. You can't accurately predict what shows will succeed. If you could, there would be only top rated shows on TV and no films would fail.

In a highly competitive and fickle marketplace you can't know with certainty what shows will succeed. Because of this, studios and networks try and hedge their bets by leveraging pre-sold markets and existing franchises to try and insure success, but I don't see how you could use that to pay off a cash equivalent to residuals.

Additionally, residuals are paid at fixed, negotiated rates, and are thus immune to the shaky finances and vagaries of the studios--at least to a point.

You'll notice that the recent lawsuit by Alan Ladd Jr. and Jay Kanter against warner brothers was about the division of gross revenue--something you'd think the studios couldn't fudge the way they do "net" profit.

http://www.hollywoodreporteresq.com/thresq/litigation/article_display.jsp?vnu_content_id=1003620696

"Most definitely there was some manipulation going on," said juror Don Prudhomme, 60, adding that the studio's experts failed to convince the panel that the allocations among films were justified. "They control all the money and the paperwork and they say, 'We'll keep all the money and allocate it however we like.' "

OT: Anti-Spam code Ah...finally a chance to use my limited Sesame St. Spanish!

"Also, why can't the relevant parties demand up front payments--sans residuals--that are more or less equal in PV to what they'd get with residuals? "

Because you don't know how successful a show is going to be in advance. I'd say that residuals are a form of profit participation/shared risk. You can't accurately predict what shows will succeed. If you could, there would be only top rated shows on TV and no films would fail.

In a highly competitive and fickle marketplace you can't know with certainty what shows will succeed. Because of this, studios and networks try and hedge their bets by leveraging pre-sold markets and existing franchises to try and insure success, but I don't see how you could use that to pay off a cash equivalent to residuals.

Yes, but they should be able to guess based on a producer's track record. I assume prediction markets can intuit these things fairly well. When investors buy an equity slice of a business, a stock or private equity deal, they are guessing what the stream of discounted cash flows will be. These depend on the success of the business and the expectations built into the stock/business price. So guessing what these payments might look like is not a stretch.

Residual deals seem to me to be fundamentally flawed because they are in fact equity-like financial structures, but not with equity-like payouts. Instead, these are based on contractual payouts in which the "wage earners" are fooling themselves into thinking they are earning wages without the risk of equity participation. They are in economic logic actually equity participants to some extent, and if they get "screwed" (by their lights), well, maybe this is the market's way of saying you can't fool mother market, sucker.