Thursday, September 11, 2008

Hollywood VORP

Forbes magazine recently posted an annual review of the most overpaid movie stars. I’ve seen this linked on Yahoo, MSNBC, and various other places on the Internet. While I see some commentary about the list, everyone seems to take it at face value.

It’s extremely difficult to judge the actual value a movie star has on a movie, because you can’t separate the star power of the actor from the actual quality/marketing/buzz of the movie, and some combination of these things is what drives profits. To me, the true value of Russell Crowe is the dollar value of profit that he adds to a movies profit over what another actor would contribute in the same movie (released at the same time, same script, etc.). I think Forbes has a big flaw in their analysis, which I’ll try to illustrate, because they entirely focus on the ratio of the profit to the actor’s salary.

Forbes’ list is derived from a “payback” figure they compute to determine how fairly paid the star is in relation to studio profits. Below is the gist of how the figure was computed:

To calculate our payback figures, we took half of each film's worldwide box office (to roughly approximate the studio's cut of each ticket). Then we added the first three months of DVD revenues and subtracted the budget to derive the film's gross income. After that, the actor's total compensation (upfront pay plus any money earned from sharing in the film's profits) was divided into the gross income to get the actor's payback figure for the film. The payback for the last three movies for each actor was averaged to calculate ultimate payback. We deliberately used gross income rather than net income in our analysis because the latter figure is so easily manipulated by studio accountants, with marketing expenses treated differently for almost every film.

So it’s obviously more of a ball-park calculation, but, still, it sounds like a lot of thought went into the analysis.

Here’s an excerpt from the results:

Our list of the top 10 overpaid celebrities is rife with some of the biggest names in Hollywood. Tom Cruise ranks third with a $4 return for every dollar he was paid mostly because of last year's stinker "Lions for Lambs," which Cruise's studio, United Artists, produced. For every dollar the star earned the film returned only $1.88.

That the list is rife with the biggest names in Hollywood should be obvious, since the analysis focused on stars whose average fee was over $5 million and, more importantly, it severly penalizes big paydays, even if they are justified.

Cameron Diaz may be the highest-paid actress in Hollywood, with $50 million in income between June 2006 and June 2007, but studios might want to question whether she's worth the money. Her films returned a lowly $4 for every dollar Diaz earned.

The main problem is that their value is being distorted by only focusing on how much the movie’s gross income was in proportion to the actor’s compensation. They should focus on the impact the star had on the dollar value of the profit, not the percentage.

Here’s a very extreme scenario to prove my point:

Let’s say Tom Cruise is compensated $1 billion for his role in “The Little Albino That Could: The David Eckstein Story”, which we’ll just call “the movie”. The movie has a budget of $1.1 billion, including Cruise’s comp – so $100 million of non-Cruise budgetary costs. The movie then has gross receipts of $4 billion (the ½ box office + DVD sales). $4 billion less $1.1 billion is $2.9 billion of “gross income” as defined above. $2.9 billion divided by $1 billion is a “payback” of a mere $2.90 for every dollar that Cruise earned.

Now let’s say that David Eckstein stars in the movie, and is paid $5 million for his efforts. This is the same script, same director, same everything else except lead actor. David Eckstein grits out a tough movie, but ultimately doesn’t have the box office pop that Tom Cruise does. The movie grosses a highly respectable total (ludicrously high for a movie staring David Eckstein) of $300 million. The budget is now $105 million, leaving “gross income” of $195 million. The movie’s “payback” is a kickass $39.00 for every dollar earned by Eckstein.

$39.00 would make Eckstein a world class movie value and underpaid in the eyes of Forbes. Cruise would be way overpaid at $2.90.

So if you own a studio, would you rather make $2.9 billion in the first scenario or $195 million (that’s 93% less) in the second? I’ve rigged the analysis to look ludicrous to prove a point.

Further exacerbating the flaws in this analysis is the fact that top flight movie-stars typically earn a portion of the profits (as Forbes notes above). Movie accounting is terribly complex and I don’t have the requisite industry knowledge to really be thorough here (or the time to do the research), but I suspect what further skews these results is the fact that top stars often get a piece of the profits once the movie is in the black, which narrows the proportional gap between the movie’s profits and their pay….but only because the movie was wildly profitable, partly because of the star.

Let’s run through an example to show how Forbes’ analysis is distortive:

Again take two exact same movies and budgets – more realistic numbers (but still made-up and probably retarded). Use a budget of $50 million, except for lead actor’s pay. Eckstein and Cruise both agree to a $5 million base salary, except Cruise is a big star, is also acting as a Producer and will be heavily promoting the movie. So he is going to get 30% of the profits (in exchange for taking such a low base, for him) after the movie has gross receipts (the ½ tickets + DVD’s) of $100 million – to cover marketing and other ancillary costs that must be recouped by the studio on top of the budget. If the movie makes $100 million, then the "payback" for both Cruise and Eckstein would be $9.00. But a movie that makes $100 million with David Eckstein as its big star might make $300 million with Cruise, which is why he’d command a share of the profits. In my model, at $300 million, Cruise would take home $65 million. Forbes would say that his “payback” is only $2.85 per dollar earned. In their eyes, Cruise is 3 times more overpaid than Eckstein, because Eckstein’s pay as a percentage of gross profit is much less. But Cruise’s movie had “gross income” as defined by Forbes of $185 million compared to Eckstein’s $45 million. He only made more money because his movie generated more.

How is Cruise overpaid in relation to Eckstein in that scenario? I think the studio would happily take the extra $145 million. The only risk to the studio was that the movie was so good that Eckstein could have carried it to the same gross income (before 30% profit-share) as Cruise and the studio could have pocketed that profit-share money. I do realize how off these numbers are to reality, but the theory should hold.

I’m not saying Forbes’ method wouldn’t point out some overpaid stars, but I think it’s a terrible way to conclusively list them. In Forbes’ defense, I think they sort of realized the flaw in their logic and used the $5 million per picture floor in computing the pool of actors to review, which removes extreme outliers (if you paid me $.01, I could have a higher payback than any actor). But I have to think this can be done in a better way. The other glaring issue is that the movie may make no money for various reasons that have nothing to do with the ability of its star to generate box office receipts. The movie, not the star, could just be terrible – that doesn’t mean the star is overpaid.

Forbes had this revelation later:

In general, actors who earned under $10 million per picture did better on our list.

This is not surprising. If you pay Jennifer Love Hewitt $5 million and Angelina Jolie $15 million, the Jolie movie’s gross income doesn’t need to be triple Hewitt’s to justify the cost, it just needs to be $10,000,001 higher. Forbes would require Jolie to generate three times the income, and that makes no sense. There’s no variable costs tied to Jolie that would justify that extra profit burden on her.

So how should Forbes have modeled the calculation to be more reflective of the actual return on the actor’s value? Is there some way to measure a Hollywood equivalent of baseball’s VORP? VORA - Value Over Replacement Actor...tied to movie profitability? There probably is, but it would take someone with intimate knowledge of Hollywood’s accounting/compensation practices and someone much smarter than me to build that model.

1 comment:

m@b said...

Seems like more of a job for a regression more than a calculation.