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Wed, 01/27/2010 - 19:00 -- Nick Dager

There are independent exhibitors who are successfully making the transition to digital cinema. But all over the world there are hundreds thousands more who are not taking part. These are the people who own and operate businesses with five screens two screens one screen and they currently face significant roadblocks in making the move to digital. With the existing DCI specifications the current VPF models aren’t working and most small exhibitors will not survive. The US and Canada are not alone in this. In fact the problem may be more urgent in Europe where a large number of exhibitors run single screen theatres. The VPF model was being debated in Europe last week and the following example uses Euros but the situation is very similar to what is going on in the States. The existing VPF systems in place are based on a traditional distribution model that is then applied to the financing of digital projection equipment. This is partly because banks and financial institutions aren't prepared to finance such a large investment unless the exhibitor has a viable historical track record.

The basic premise of the need for the VPF models is that exhibitors face all the costs while distributors get all the benefits.  When any business makes an investment decision it should do a cost-benefit analysis. Let's imagine you are a cinema exploring going digital. And let's also imagine that you want to be DCI-compliant to have access to the maximum choice of films. Let's say the upfront equipment cost is €100 000 and its expected useful life is five years which is probably prudent since we are talking about electronic equipment. If you assume your finance costs are 10 percent and you have extra annual maintenance costs of €10 000 you would need to be showing savings/increased revenues of €35 000 per year to be able to consider such an investment worthwhile. Different cinemas may have lower finance costs and bigger or lower increases in revenues. For example multiplexes may save on the costs of manpower because they only need one projectionist per shift instead of at least two to carry around and splice 35mm film platters. On the other hand remote cinemas may show higher revenues because they can get films in the first week of release instead of having to wait for weeks for a 35mm print to come around.

 There's some debate about the useful life of the equipment. Some say it's five years others 10 others still seven. We won't know for certain for a while. Even with a 10-year life the annual savings/extra revenue required to justify the investment wouldn't be a lot less because cash flows in the distant future are worth less than the same cash flows in the near future especially once you factor in their uncertainty.

 The ticket price for a (non-3D) digital screening is the same as for a 35mm screening: €7.50. So to get say an extra €20 000 of revenue per year we're talking about an extra 2 700 admissions per year compared to 35mm projection. That's 52 extra admissions per week from a single screen. Of course you might recover something from selling off your 35mm projector second-hand too.

Now this may be feasible if you increase the choice of films available on your screen. That may not be acceptable to the distributors though: if they are sending you a disk drive with their film on it they want you to show their film for all shows if possible.

In the VPF model the maximum fee charged to the distributor is the difference between the cost of a 35mm print and a digital print. This works on the basis that a distributor cannot be worse off from releasing a film digitally compared to releasing it on 35mm. Let's imagine that a 35mm print costs €1 500 (or €1 200 for major distributors with volume discounts on film processing) and a digital print costs €100. The maximum total VPF payments which a distributor would be prepared to make is therefore €1 400 (or €1 100 for major distributors).
Typically there's a VPF payment when a film reaches the maximum number of screens in a given week of its release. Let's say Film A is a blockbuster and Film B is an art house film.
The traditional release pattern for Film A would be to go wide stay in the same cinemas for a few weeks and then move on to second-run cinemas etc. The traditional release pattern for Film B would be to open on a small number of screens usually in capital/major cities and be shown for 2-3 weeks before moving on to other art house cinemas and playing in repertory.
 The VPF payments for a digital print of Film A would be say €600 in the first-run cinemas x2 in the second-run cinemas x3 in the third-run etc. The total of x2+x3+... cannot exceed €500 (€1 100-€600). So unless the VPF rates for releasing Film A after the first-run fall away dramatically there's a built-in disincentive for distributors to go beyond the 2nd or 3rd run cinemas. That could have an impact on repertory releases of even blockbusters.
If the VPF payments for a digital print of Film B were charged on the same basis as for Film A the effect of the disincentive would be to limit the circulation of Film B even if the maximum VPF smaller distributors would be prepared to pay is higher (€1 400 versus €1 100): the wider the release the higher the VPF payment per print. Some integrators are flexible enough to offer different VPF models to different types of distributors and exhibitors. Evidently the traditional release pattern for art house films could generate more VPF payments (more art house films per year) so a model based on for example lower fixed VPF payments per cinema for all weeks of the release may work out overall for the integrators when dealing with distributors of such films. This is illustrated in this article: though their illustrations don't really go beyond the first-run release period.
 With digital distribution what we should have seen is different and flexible release patterns for each film adapted to audience interest in the film. For example Film A would be released as widely as possible and then be retained on fewer and fewer screens as audience interest moves on to newer releases. Film B would start small and grow wider as word-of-mouth spreads before falling away again. Supply would follow demand.
A fixed fee per screening for each projector is therefore more likely to allow this flexibility than the weekly fees the VPF models seem to apply. However that may not be something the distributors signing up to VPF deals would go for as it would leave cinemas open to program operas football matches concerts etc at will depending on what their audiences want to watch. That in turn would allow cinemas to maximize their revenues ... maybe to the extent of being able to afford the extra cost of digital projection equipment without having a VPF deal. There's also the issue of distributor-exhibitor agreements which are often mainly based on weekly terms too at least for the major distributors. At the same time the traditional distribution economics remain in which the distributor has to apply its print budget to providing prints to those screens which generate the maximum revenues. This in turn is likely to mean that the smaller more remote cinemas still won't get to show new releases in the first week.

In this scenario smaller distributors (and there are a lot of them in Europe) who might have benefitted from the digital transition probably won't because their access to screens will remain as blocked as before since the economics won't have changed as much as they could have done.

Quite apart from the financing mechanism there's the technical backup needed to keep digital projection equipment up and running. That isn't necessarily going to be provided by a bank or by the equipment manufacturer. By my calculations this can be as much as €10 000 additional maintenance cost per year.

Now there are cinemas which are investing in the equipment themselves possibly with the help of bank loans. Hopefully they will have done their investment calculations using realistic assumptions. Otherwise they risk going under either because the financial benefits don't materialize or because the equipment doesn't last as long as they had expected it to. The situation is different in India in large part because India has its own established local production business and can rely less on Hollywood releases. For this reason there is also greater flexibility regarding the technology and many theatres continue to operate with digital systems that are not DCI-compliant.

Indian digital cinema network Ufomoviez designed its financing mechanism with the digital scenario in mind and doesn't start with the premise that cinemas will be the losers while distributors will be the winners. The company makes the investment itself and leaves it up to the exhibitors to decide whether or not and when to show films digitally on a per-screening basis. The equipment is small enough not to need major changes to the projection booths and can be installed in parallel to the existing 35mm projector(s) of a cinema. The transmission format is also light enough to allow films to be transferred by satellite.

Exhibitors then retain flexibility while distributors are usually only looking at a net income from including their film on the network's database apart from a one-off encoding cost which may be absorbed by the network itself. In practice exhibitors have evidently found it a much more interesting bet than 35mm. Their revenues especially in cinemas which were not previously first-run cinemas are much higher than in the 35mm scenario.

 Tellingly the Indian network assumes that its digital projection equipment only has a useful life of three years and has done its investment calculation on that basis. For example initially they were installing 1.3k projectors and now they are installing HD projectors. They are also responsible for maintaining the equipment.

You can tell what a difference this makes to the pattern of film distribution if you look at their statistics The number of screens showing even the latest hit films falls away dramatically after the first couple of weeks and only a few are shown for more than four weeks.

 What film audiences seem to want from their cinemas are choice a personal touch a pleasant environment and fair prices. The Indian model appears to deliver all of these at minimal upfront outlay for both exhibitors and distributors. It's not surprising that it now includes more than 1 700 (13 percent) of India's 13 000 cinema screens after just four years of operation. True they can't yet show 3D films although that is certain to change. However after one or two years will audiences really pay extra for 3D?

Fundamentally the problem of the DCI specifications comes back to the relatively high cost of the equipment which more-or-less meets them compared to the return to exhibitors and to distributors. It's not surprising that many are asking if it's worth it when with the exception of 3D most patrons can't tell the difference between digital and film projection.