The film & television production industry

Alliance Communications Corporation in the global environment

The filmed entertainment industry produces cinema theatre releases and television product for viewers around the world. The industry is dominated globally by the members of the Motion Picture Association of America: The Walt Disney Company, Sony Pictures Entertainment (Sony), Metro-Goldwyn-Mayer, Paramount Pictures Corporation (Viacom), Twentieth Century Fox, Universal Pictures (Seagram Co.), and Warner Bros. (Time-Warner). "The facts speak for themselves. We own radio and television networks, but in English Canada most of the stories available to us are American."

In the rest of the world, the industry is highly fragmented. Those countries that have been able to develop a reasonable indigenous film and television industry have done so with government assistance in the form of protectionist policies and subsidies. In Porter’s terms, Government has been a critical element of this industry’s national diamond. From France to Mexico, from Australia to the U.K., Government policies have been instrumental in the development of the industry, its related and supporting industries, and its factor conditions, such as skilled production labour.

Canada is a prime example of this. Tax shelters and credits, Telefilm and Provincial funding, Canadian Content rules, etc., have contributed immensely in the development of an indigenous film and television production industry.

Alliance Communications Corporation prospered in this environment to become the largest producer in Canada. After eleven years in existence, Alliance is a publicly traded company with offices in various countries and exports exceeding one hundred million dollars. While its main area of competition is North America, Alliance’s vision is to be a Global Player. Therefore, we will explore the industry environment in the United States, Europe and Canada. Even though there are producers in many other countries, these are the most important and profitable markets.

The industry boundaries are blurring. Today, most of the original movie studios are part of larger conglomerates involved in many other businesses. These companies do not define themselves as being in the film or television business, but rather in the entertainment business. Joint ventures, alliances and acquisitions have increased in the past few years. One of the drivers is technology. The fragmentation of delivery channels and the proliferation of computers and the Internet are having a profound effect in the industry. New players to the entertainment and production game are emerging from other fields. For example, Microsoft, Disney, Time/Warner, GE/NBC, TCI and News Corp. are involved in numerous ventures, which have prompted analysts to call this an American Keiretsu.

It is important to recall that U.S. based companies are not necessarily American. Japan and Canada control two of the major entertainment firms. One of the tenets of the American lobby is that protectionist policies are a two way street. The U.S. allows foreigners to control its film studios and this should be reciprocated.

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In the past few years, the audiovisual industry has been growing worldwide. In 1995, the industry worldwide represented US $168 billion. Growth in the industry was as follows:

In Europe the television industry is growing faster than in the United States. Whereas before, TV’s revenues mainly stemmed from advertising and license fees, today PAY-TV is growing twice as fast as free TV.

The industry is concentrating worldwide. In 1995, the top 100 companies had 13% of the revenue of the industry and among these, the top 5 represented 39% of the revenues of the top 100 cumulated. The top 5 companies are Time Warner (USA), Walt Disney (USA), Viacom (USA), Sony (Japan) and Bertelsmann-CLT (Germany). But these are not the most profitable companies. Companies that make the most profit are in fact the specialized one.

In Europe itself, German companies represent 35% of the revenues, the UK companies 25% and French companies 11%. The rest of it represents 29% of the market. The European industry is largely dominated by the American production and the balance of trade between these two poles of the triad remains in favor of the US.

Imports form the US to Europe: $6.8 billion US

Exports to the US from Europe: $0.6 billion US

Even though the industry is growing in Europe, the competition is harsh due to the majors that are powerful the world over. Indeed, in addition to a very concentrated industry, European companies tend to merge or create alliances to produce and distribute. Arte, for example, is a French-German television channel. Its legal status is as a European Group of Economic Interest or GEIE. These ventures are considered part of the cultural industries and as such are highly protected by the government.

In Europe, two levels of regulations and grants need to be taken into account: national and European. Indeed, the European Union laws are applicable in all European Union countries before national laws. The EU supports European producers through programs like the MEDIA II Programme. On October 1996, Mr. Oreja responsible for information, communication, culture and audiovisual media announced that grants will be awarded to more than 100 independent production companies for the development of projects for the audiovisual market. Loans amounting to ECU 4 million were awarded to companies in 14 Member states of the EU. The 4 million should be going either to program making projects (Drama, documentaries, etc.) or to production companies, or production using new technologies and even to operational costs, personnel and equipment. Support is also forwarded to these medium-sized production companies who have a potential to develop in Europe and also worldwide.

Ten years ago, the film industry in the UK was considered as dead and buried. The cinema admissions had dramatically dropped to 50 million a year and the number of films produced amounted to only 30 a year. "Last year more than 120 million cinema tickets were sold in British cinemas and there were a 127 productions. Not much compared to the statistics of the United States, I know, but concrete evidence of a rapidly expanding market in the UK", said secretary of state Chris Smith in his speech at the consul general’s reception in Los Angeles on October 24th, 1997. The UK government has decided to boost its industry to take market share away from American productions. the government has almost reached its target of doubling the British film industry at the UK box office. The government has implemented a seven-point action plan "for helping the film industry to develop from a series of small crafts businesses into a properly integrated modern industry."

There are 50 channels and among them, two are public channels (BBC1 and 2), three are private channels and forty-four are pay channels. Although competition increases for the BBC, its audience is still of 42% today. The BBC has a mission and this mission, as well as its powers, is regulated by the BBC Royal Chart. On the other side, the private sector depends on the Broadcasting Act and licenses are granted for ten years.

The British channels must abide by the European. Quotas are set up for European products. At least 25% of broadcasters programs must be acquired from independent producers. This is also a high barrier to entry for such companies as Alliance who see themselves stuck between the big Majors’ productions and the quantities of European products that channels have to show.

However there are opportunities in the cable and satellite channels. These channels are regulated by European legislation (10% of on air show or 10% of the program budget must come from independent European production). This legislation is not as strict as national laws.

Another organization is the C.S.A. ( Conseil Superieur de l’Audiovisuel ) which is the equivalent of the Broadcasting Standards Council in the UK. Its mission is to make sure that competition is fair, that the programs are numerous, and that national audiovisual productions develop.

In France there are four public channels (France 2, France 3, Arte, La Cinquieme), three private ones, one of which is a pay-channel, Canal +. In addition, there are twelve cable channels and nineteen satellite channels. But the French are not yet familiar with cable. Only 1,423,720 people are subscribing to cable against 20.9 million people who own a TV. It was only in 1982 that the law abolishing the state monopoly in broadcasting was created.

Quotas for television in France are:

• 60% of what is shown has to be European. Of this 60%, 40% has to be in French on the hertzian channels and 50% has to be European production of which 50% has to be in the French language.
• For production, the hertzian free channels must dedicate 15% of their revenues and 120 hours of air-time to French programming. The pay channels such as Canal + must use 20% of their revenues coming from subscriptions and advertising to European programs among which 50% needs to be in the French language.

Other mechanisms are settled to support the French independent companies. For instance, the public channels can agree with the C.S.A. to support such companies by buying their shows.

Therefore, we understand here how high the barriers to entry are to get into the French TV industry. Unlike the UK, French have, in addition to using the European legislation, very stringent regulations in terms of quotas.

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In terms of movie theatres there is in France an oligopoly. Indeed, three companies: UGC, Pathe and Gaumont own most of the movie theatres and more specifically the multiplexes. They don’t just play the movie, they play the movie thanks to a better sound, a better image, etc. Today they also started distributing the movies. In France, the television and movie industries work side by side to preserve the French cultural exception.

The general move goes towards concentration. For instance, Havas merged with the Generale des Eaux in order to reach a critical size. But most of all, despite these general trends, which happen to be the same worldwide, the film and movie industry is a digest of the French cultural exception. And that explains why the independent French productions benefit from the government’s help. For instance the French government limits thanks to quotas the distribution and the financing of audiovisual groups in order to maintain the independent sector alive. This sector is kept alive not only because these groups that are able to grow are restrained but also because they find artificial openings to sell their products. All these mechanisms are in place to have a cultural model, the French, survive. The following figures reinforce the above statements: in 1995, 147 films were produced whereas there are 1,600 production companies. In other words, as French film production decreases, the number of production companies increases.

In terms of distribution, there really are twenty active distributors. These are Gaumont, AMLF, UGC, and then the majors ( Warner, Fox, Colombia Tristar, etc.), and after that, more modest structure exist such as Bac Films, MK2, etc.

Television represents 37% of the financial volume of French production but despite the systems put in place, the American movies keep constant attendance rates whereas the French film productions keep on seeing their audience decrease. In 1995, the 30% of the revenues of the film industry came from French movies but the rest came from American and other foreign movies. Today many French productions that are successful are shot in English, such as The Fifth Element or Highlander.

We can see that barriers to entry are really high in France for the international independent companies such as Alliance. Indeed the French arena has on one side the majors and on the other side French independents that are heavily helped by the government and for which barriers to entry are incredibly low on their national market. This is without mentioning the evolution of the industry, which as protected as it is, still follows the trends of concentration, integration and consolidation.

In recent years, the Canadian film and television industry has changed a great deal. Following the lead of their American counterparts, many Canadian firms have grown as a result of their acquisition of both Canadian and American companies. This process has allowed for the emergence of a handful of fully integrated film and television companies, with the most notable being, Alliance Communications, Paragon Entertainment, Atlantis Communications, Nelvana Limited, and the recently formed Lions Gate Entertainment. They have been able to grow their core businesses through increased capitalization from public-share offerings. This strategy of growth and consolidation has allowed these companies to become more competitive in the global arena. Their dominance within Canada has increased their international credibility and visibility. Even though they remain small in comparison to the large American companies, they have helped built and strengthen the Canadian film and television industry. In fact, Canada has become the second largest exporter of television programming in the world.

In many ways, acquisitions have been used to create vertically integrated companies. This practice is widespread, ranging from large companies such as Disney to small independents such as Atlantis. It has allowed companies to control both the downstream and upstream elements of their supply chains. It is an interesting strategy because it allows companies to produce television programs while airing them on their own channels. However, the vertical integration of the entertainment companies in the U.S. (Disney-ABC) is making it more difficult for Canadians to place their shows on the U.S. networks. This is why there has been an increased amount of activity directed at European and other non-American markets.

In Canada, regulation and government funding have played important roles in the development of a Canadian industry. The imposition of content rules (TV) has limited the effects of external competition. However, regardless of the level of regulation, it is essential that good products be produced, otherwise they will not be consumed. Funding is offered both federally and provincially and has become an important part of financing. Other incentives such as tax credits are also offered to help shift the financial burden. Regulation and funding are not just Canadian practices; many countries play active roles in the protection and development of their cultural industries. Without it, many would fail.

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Trends in the Film Industry

In the past decade, the filmed entertainment industry has experienced a tremendous increase in worldwide demand. This $45 billion dollar industry (which includes video and pay TV) has realized an annual growth rate of 10% over the past ten years. As the new millennium approaches, many production companies are looking beyond the North American border for growth opportunities. There is some evidence that the growth prospects in North America may be leveling off. However, the international marketplace (outside North America) may offer new growth opportunities for North American production companies. International box office receipts have grown to represent more than 50% of the total world box office. While the international marketplace is an outlet for further growth, it is not the only driving force in the industry. A major force in the increasing worldwide demand is the creation of new channels of distribution, fueled by advances in technology.

Technology has been, and will continue to be, a driving force in creating more windows of opportunity in the film industry. Not long ago, a movie’s life cycle consisted of three generic stages: theatrical distribution, television syndication and library storage. In the past decade, technology has helped create many new channels of distribution in this industry. Paid cable viewing (i.e. specialty channels, pay TV, pay per view), VCRs, and satellite technology, have helped extend the life cycle of a movie The emergence of new windows of opportunity for filmed entertainment has been a key factor in generating the growth level the industry has enjoyed. The greater number of avenues available for filmed entertainment products has extended the profit stream realized by film production companies. There is no indication that technology will cease to provide new windows of opportunity in the future. Recent developments such as digital transmission, multi-channel cable, video on demand, and the Internet, are all potential opportunities for further growth in the filmed entertainment industry.

Industry insiders believe that DVD will be the next major media standard for film content. The implications of this development are quite similar to the implications of past technological developments. Technology has enabled movies to be taken out of the movie theater and put into the home. Providing consumers with the opportunity to enjoy a filmed product in their own home has dramatically expanded the potential consumer base. Like its predecessor (VHS), DVD technology will make watching a movie at home more pleasurable and convenient, thus driving demand for filmed products. In addition to increasing the potential consumer base, new technology rapidly replaces existing technologies. The importance of this trait is that it allows retrofitting by consumers and the potential merging of product streams. Consumers who purchased a particular VHS movie in the past, may be inclined to purchase the same movie in DVD format in the future. Each new wave of technology offers the consumer added value by increasing the quality (image, sound, longevity) of the filmed entertainment product.

While new technology has helped drive up production costs, it has also enabled firms to generate more profit. The profit stream from film products is extended by new technologies such as DVD. Production companies can enjoy these extended profit streams as long as they maintain the rights of their productions. The importance of extensive product libraries of films becomes crucial in the advent of rapidly changing technology. By creating new outlets for old products, the emergence of new content delivery channels increases the potential worth of product libraries. These channels are especially attractive to production companies because the cost incurred in producing these products occurred long ago. Hence, the profitability of such venues is extremely attractive.

In addition to creating demand for old products, the fragmentation of content delivery channels creates new pools of revenue and expands the potential markets for new products. Once again, the international market becomes an important element for further expansion in the industry. New technology can fuel additional demand in North America; however, technology’s role in the industry goes beyond the North American border. Future developments, such as movies on the Internet, will enable the filmed entertainment industry to transcend the traditional barriers to entry in foreign markets. New developments will continue to push this industry towards a truly global marketplace, where a firm’s ability to market its product internationally becomes critical.

By far the biggest obstacle all Canadian independent producers will face in the coming year is deregulation. As it stands know, Canadian producers are guaranteed a certain number of hours on Canadian TV. The pressure to harmonize policies with the United States threatens the Canadian content rule. NAFTA has already reduced trade barriers in virtually all industries. The film and TV industry is one of the last protected industries in Canada. Elimination or decreases in the Canadian content rule will adversely affect all independents. It will virtually cripple a dependent content delivery channel for Canadian independent producers. Canadian broadcasting companies would most likely chose to air the more popular U.S productions. The more popular U.S productions often cost the broadcasting company less than Canadian productions do. The cost advantage provides further incentive for Canadian broadcasting to shift to U.S productions, if given the choice.

The Canadian government has reduced the amount of subsidies and loans given to Canadian film production companies. There is no indication that this trend in reductions of government subsidies will reverse in the near future. Many independent companies need these funds to finance their already low cost productions. Capital is critical in this industry and most independent producers simply do not have many avenues for financing. The larger independents in Canada are looking towards new financing alternatives such as off balance sheet financing and partnerships to finance their productions. Nonetheless, the possible elimination of these subsidies and loans, coupled with deregulation, could spell disaster for many Canadian independents.

The company is primarily involved in the production of filmed entertainment with a strong concentration on product for television. It is an integrated company. Upstream, it produces features for theatrical release and television projects for broadcast. Downstream, it is a distributor of its own Canadian films, as well as other Canadian and International releases. Also downstream, it owns two specialty channels where it broadcasts its own product as well as product acquired through acquisitions. Recently, the company entered into a joint venture with Shaw Communications to launch a video-on-demand service to increase its product delivery channels.

Alliance also has been successful in the area of financing. "In addition to acting as a broker to arrange structured financings for independent third-party producers, Equicap assists in funding many Alliance productions and has helped attract a number of independent productions to Alliance for distribution." Recent legislation regarding tax credits for film production has had a negative effect on the division and even though the company says it has prepared for this, the near term result will be a decline in revenues. Equicap has been the most profitable division. Almost have of its revenues is gross profit.

Since going public in 1993, Alliance has pursued the above strategies aggressively. It has consolidated as the largest producer and distributor in Canada and it has continued to make inroads into the coveted US market as well as international territories. It has been careful not to compete head to head with the global giants, U.S. headquartered studios. The way Alliance has done this is by carefully maintaining its position at home and following a pre-sales international strategy, wherein, its projects are pre-sold internationally, primarily to television stations, before the commencement of principal photography.

The company has continued along this path in recent months by acquiring two more companies in foreign countries: Electric Pictures PLC, a London-based theatrical distributor and Citadel, a Los Angeles-based television production company. In keeping with the company’s overall strategy of securing delivery channels and increasing product in the form of film libraries, these two acquisitions put Alliance in a better position to compete internationally.

Alliance’s distinct competency is deal making. The company makes deals better than any of its Canadian competitors. CEO Robert Lantos’ business sense and acumen are well known in the industry and his relationships are very powerful. Proof of this is the fact that one of the directors on the board is Pierre Desroches, who was the head of Telefilm Canada, the funding agency, until a few years ago.

• Strongest competitive position in Canada as the largest film and television producer.
• Packaging, developing, pre-selling and producing television content.
• Largest Canadian film distributor
• Long-term agreements with Miramax, A Disney company, and New Line to distribute their films in Canada.

• Strong leadership – Robert Lantos’ vision and his talent for deal making have guided the company since its inception
• Access to capital markets

• Strong Leadership – Robert Lantos’ power in the company may preclude careful analysis of strategic issues. The failure experienced with the Hungarian television venture is an example. Jay Firestone, Mr. Lantos’ right hand man, left the company two years ago over disagreements with Lantos. He started his own company, which produces television series.

• The inability at this stage to completely produce projects without any government assistance. A considerable portion of revenues and investment in film production comes from government funding and grants.

• Alliance’s size is still a major weakness. As Lantos has said, "Our real competition is not other Canadian companies but U.S.-based international conglomerates. We are battling for shelf space against the behemoths."

Opportunities

• Growing demand for television product around the world, as audience fragmentation continues and as technology continues to develop delivery systems, such as direct-to-home satellite delivery, increasing number of cable channels, wireless microwave delivery systems, the internet and broadcast convergence, etc.
• Possible mergers and/or acquisitions in the Canadian Industry. The company has not demonstrated an aggressive stance in this area, but given the importance of size, it is an opportunity to explore. Possible targets may be Nelvana, the largest Canadian Animation Company, Paragon Entertainment, television producer and Atlantis, one of Alliance’s main competitors in Canada.

Threats

• Continued reduction in government funding will have a short-term impact in earnings.

• Relaxation of Canadian content rules, for which major broadcasters continue to lobby, would have a major impact on the company. If this protectionist policy is dropped, Alliance may have a very difficult time competing in the near term against the major Hollywood television suppliers.

• Even though the company has implemented a poison pill, a takeover is always a threat. MCA/Universal may want to dominate the Canadian market by purchasing Alliance. MCA/Universal is controlled by The Seagram Company and therefore qualifies as a Canadian company for regulatory purposes.
• Possible merger among the other major Canadian competitors.

strategic issues

size

Alliance has recognized that size is important to compete. Recent acquisitions in the U.K. and California are addressing this strategic intent. Nevertheless, implementation is not always as clean as the strategy that guides it. Alliance’s venture into Hungarian television has failed and the company is considering the sale of TV5 Hungary.

The other consideration regarding size is that Alliance has not demonstrated a pattern of decisions that would lead to increase dominance in the Canadian market. Perhaps this should be a top priority. Recently in Hull, Quebec the Canadian Broadcasters Association and the Canadian Film and Television Producers Association met with CRTC officials to discuss the issue of national networks. The discussions quickly turned to Canadian drama on Canadian television. Robert Lantos, Alliance’s CEO and the most visible of all producers, berated the broadcasters to the point of saying "Hiding from the competition by ducking the most watched time periods is not the way to build bigger domestic audiences and demand for Canadian programming. It is not the way of the future. It is tantamount to surrender. If the broadcasters find the business of putting a modest amount of Canadian programming in prime time too onerous, I would be delighted to buy their business."

It is not clear to us how serious is Mr. Lantos regarding his statement. At the present time, broadcasters are precluded by law from producing their own dramatic shows. Until recently, this was the case in the United States. However, if the policies that are currently being looked at by the government change, there may be a significant opportunity for Alliance to increase its size and scope similar to Channel 4 in the U.K., one of the most important broadcasters and feature film producers in Europe.

Alliance’s vision of becoming a global provider of quality content to al media worldwide does not address the issue of technology as a component of content production and distribution. As we have previously mentioned, American firms in the entertainment field are collaborating with firms in the software and Internet businesses (Auletta). These ventures may have strategic repercussions for Alliance. Why isn’t there a venture between Alliance and companies like Discreet Logic or Microsoft (Microsoft Network Canada)? The company is not exploring, at least not publicly, new avenues of distribution and new production technologies. A telling fact is its equity reduction in Mainframe, the computer animation company with which Alliance co- produces Reboot and Beasties.

Computer animation and effects will continue to play an important role in marketable audiovisual entertainment as technology evolves and its costs decrease. Alliance should commit resources to explore more ventures in this area.

Regulation will continue to be a major strategic issue, as long as it exists. Whether policies are laissez faire or protectionist, the firm cannot afford to ignore them. As we have seen earlier, other governments are trying to reinforce their protectionist policies and it remains to be seen whether cultural industries will ever be unprotected. Mr. Lantos visibility during policy talks is evidence that Alliance will continue to lobby for its best interests.