The Effects of Vertical Integration on the Release of New Films

Abstract

This article both theoretically and empirically addresses how a vertical structure in the motion pictures industry determines the number of prints a distributor releases of a new film. A simple theoretical model shows that the optimal number of copies is increasing on the expected demand for the film and the revenue share of the distributor and decreasing on the cost of each copy. The model also predicts that the optimal number of copies will decrease with the number of theaters that are vertically integrated with the distributor, as long as running a cinema requires financing a non-negligible cost of capital. The theoretical results are empirically tested using a very rich dataset of films' exhibition patterns in the major Chilean markets. The empirical results show that, on average, a non-integrated distributor releases 8 more copies than an integrated distributor.

Notes

¹Similarly, the question of what determines the success of a movie is addressed by Bagella and Becchetti (1999), De Vany and Walls (1997), Deucher, Adjamah, and Pauly (2005), and Jansen (2005), for the Italian, American, England, and German markets, respectively.

² Canterbery and Marvasti (2001) provided an adequate description of the functioning of this market in the United States.

³ Goettler and Leslie (2005) showed the importance of risk-sharing using the contractual relationship between distributors and exhibitors in the motion picture market. Filson, Switzer, and Besocke (2005) also explained the use of sharing contracts between distributors and exhibitors as a way to share risk, but also to overcome measurement problems.

⁴In an antitrust case before the Chilean Competition Court (Tribunal de Defensa de la Libre Competencia [TDLC]), it was established by the National Economic Prosecutor's Office and also by the court in its sentence that “there are no written contracts as the relationship [of the distributors] with all the exhibitors is based on consent agreements based on the usage and customs of the industry” (TDLC, 2005). The nonexistence of written contracts is somehow consistent with the claim by Filson, Switzer, and Besocke (2005) that, in this industry, long-term relationships between exhibitors and distributors reduce the need for incentive contracts because reputational concerns provide incentives.

⁵In a report presented before the Tribunal de Defensa de la Libre Competencia by the Fiscalia Nacional Economica (FNE), it is stated that “the share of revenue earned by distributors is not negotiated with the exhibitors, as they know it beforehand. The three largest distributors (Fox-Warner, Andes Films, and UIP) keep 60% of the revenue the first week, 55% the second week and then it keeps sliding down 5 percent points each week until a minimum of 35%” (TDLC, 2005).

⁶To guarantee existence and uniqueness of an optimal N, we suppose that goes to 0 (infinite) as $% N $ goes to 1 (infinite).

⁷It is important to recall that in the case of the Chilean market, this parameter does not vary by movie or by distributor, so it must be taken as given for distributors and exhibitors.

⁸These categories are the ones used by the distributors in Chile.

⁹We also estimated a Poisson count model, which is more restrictive because it assumes equidispersion, but the overdispersion test suggested by Cameron and Trivedi (1990) rejects the equidispersion assumption.

¹⁰In several regressions not reported in this article, but avaliable from us, we included measures of profitability of the distributors, but they were never statistically significant; more important, the signs and magnitudes of the other coefficients in the regression barely changed.

¹¹We thank an anonymous referee for the idea of estimating this regression.