Seismic tremors have rippled through Hollywood from the video streaming revolution, but the underlying business feels much the same … for now. 

Although much of the focus is on the growth of content production — the number of original scripted series reached a record 532 in 2019, according to an FX Networks study — a transformation of the industry is taking place under the surface.

Digital gatecrashers like Netflix Inc. and Amazon.com Inc. are seeking to remake Hollywood’s underlying economics and the town’s corporate culture in a number of ways. 

On the chopping block, for instance, is bonus income for creative talent, which is a Hollywood fixture.

“It’s dawning on a lot of people in the business that you can’t replace the avalanche of cash that is generated by a global box office smash,” said Ken Kleinberg, co-founder and partner at West Los Angeles-based entertainment law firm Kleinberg Lange Cuddy & Carlo. 

“So there has to be a new way to share in the ‘upside’ of movies and, so far, what has happened is much of that upside has gone to streamers who are taking the risk with some very expensive projects. It hasn’t settled down yet, and I think we’ll see different paradigms emerge,” added Kleinberg, whose clients include J.K. Rowling and Jack Nicholson. 

Streaming services generally pay 110%-150% of production costs for their original content, providing a quick upfront return for producers and talent. But streaming companies retain all rights globally to that content, which can strip out triggers for later bonus income to A-list stars and deprives Hollywood distribution companies of new titles to freshen their cash-cow content libraries. There is constant arm-twisting between streamers, labor unions, talent and Hollywood companies negotiating contracts over if and when bonus compensation is due.

By not licensing their content to third parties, the streaming services are disrupting traditional “sequential distribution,” a function long favored by the major studios that involves continuously selling the same content over time to different buyers.

Then there’s streaming’s direct-to-consumer distribution model, the biggest money matter of all. Streaming services collect 100% of consumer spend, disintermediating middlemen such as TV channels or theaters. 

At the same time, major studios are increasingly using their theatrical films to bolster corporate sibling streaming services. The most radical example is the decision by Warner Bros. Entertainment Inc. to release a year’s worth of its theatrical films on HBO Max on the same day they’re released in theaters. 

Meanwhile, direct-to-consumer operators such as Disney Plus and the upcoming Paramount Plus are tapped into a treasure trove of consumer data thanks to their studio connections. 

Keeping it in house

Media conglomerates are also steering their best new TV series to their in-house streaming services. Eventually, their legacy TV channels could become populated with cheap original programing.

At the same time, established Hollywood players are repurposing some theatrical releases by selling them directly to streaming services. For example, “The Trial of the Chicago 7” became a Netflix premiere after Paramount Pictures offloaded the star-studded courtroom drama.

In the process, the audience shift to streaming has diminished traditional cable TV channels. Cable’s “big bundle” subscription model, which showered riches on Hollywood for four decades, is now at risk.

And winds of change are blowing even further afield in the media landscape where platforms, enabled by interactive digital connections to consumers, are angling for a cut of newly legalized sports gambling while providing consumers with betting information and partnering with gaming companies.

Though not related to streaming, Hollywood talent agencies lost a bruising nearly two-year labor battle with the writers’ union and are poised to give up financially lucrative “packaging fee” income connected to writers that they represent.

Of course, the Covid-19 pandemic looms large, too. It had a direct impact on production in 2020, a slowdown that has continued so far this year.

But on a positive note, “consumer spending was robust through the summer despite expiring unemployment benefits,” according S&P Global Ratings. Still, the credit agency believes that movie theaters could remain damaged “until at least 2022, if not 2023.”

Century City-based entertainment lawyer Schuyler Moore, a partner at Greenberg Glusker Fields Claman & Machtinger who worked transactions for “Chicago 7” and big-budget Netflix movie “The Irishman,” has an insider’s perspective into Hollywood’s ongoing restructuring.

“The studio model is gone,” he said. “Whoever controls distribution controls the keys to the kingdom. They get the money (directly from consumers) and decide who else gets how much money. And there’s a lot of discretion in the allocation.” 

Some pundits contend the cinemas that closed due to the pandemic will never rebound, in part citing Warner’s decision to share theatrical releases with HBO Max.
But “no other major or independent studio has announced plans similar to Warner,” notes corporate credit rating agency Moody’s Investors Service Inc. 

In the short term, a traditional cinema release coupled with later streaming provides the best economic return, especially for glossy, big-budget films, according to Moody’s. 

“A successful theatrical release ‘brands’ a film and is one of the major contributors to a film’s success in downstream home entertainment markets, as well as branded retail merchandise,” the ratings agency said.

A report by media investment research firm Moffett-Nathanson said in a statement that much remains to be settled before a new world order is declared in Hollywood. 

“Netflix and other subscription video-on-demand services, to date, have not proven effective at creating scaled franchises like those at Disney through exclusive theatrical releases,” the firm said. “Most believe that once we see a return to some new normal level of moviegoing, there will ultimately be more of a hybrid model with shorter windows (between theatrical and video streaming). The general expectation is that big ‘tentpoles’ will still get a theatrical release, but mid/small-budget films will increasingly move exclusively to streaming.” 

Netflix questions

Over the decades, Hollywood has shown a knack for co-opting would-be conquerors whether radio, TV, conglomerate mergers swallowing up major studios, cable TV, or the first dot-com invasion two decades ago. 

The current streaming invasion is spearheaded by Netflix, with its $25 billion annual revenue and a stock market capitalization of around $250 billion. But the streaming service, which was only founded in 1997, has some chinks in its armor. 

Its corporate credit rating is in the speculative, or junk-bond, classification — mostly because of spending on programming and costs for building out its global distribution, which is now largely completed. Netflix spends an estimated $15 billion-$18 billion on content, producing original TV shows and movies, as well as on licensing acquisitions. In comparison, the slate of new theatrical movies at Hollywood’s top distributors costs under $10 billion annually. 

At stake in the unfolding streaming revolution is what version of Hollywood endures. The legacy structure has a handful of major studios dominating a sprawling, diverse ecosystem. The alternative is a narrower company town ruled by streamers by virtue of their direct-to-consumer distribution chokehold on revenue.

Keep reading the 2021 Money Issue.