|
I. Introduction
It's here! That is, distribution of films on the Internet, and it will have the
same revolutionary impact on the film industry as the introduction of video in
the '70s. It will require a complete rethinking of the film business, and the
streets will be lined with dead bodies and lottery winners.
--------------------------------------------------------------------------------------------------------------------------------------------------
II. The How
Already, films that are shot on celluloid can be subsequently transferred to a
digital file that is stored onto a computer server located anywhere in the
world. In time, films will be shot digitally in the first instance, which will
make this process easier. It will also expedite digital transmission of films to
theaters. (Ah, but that is another story…) The server can hold many films, and
anyone with a personal computer will be able to access the server and download
the film (for a reasonable fee, of course). There are several barriers to making
this a reality, but these barriers are rapidly falling:
--------------------------------------------------------------------------------------------------------------------------------------------------
A. Speed. Using a normal modem, it takes a
full day to download a two-hour movie. There is currently available high-speed
download technology, but it is relatively expensive. It is only a matter of
time, however, before the cost drops and the technology becomes widely
affordable. The next widely anticipated development is the implementation of
broadband technology (the equivalent of unwinding a string into its separate
strands), which will permit the rapid transmission of massive amounts of data,
permitting the rapid download of films.
--------------------------------------------------------------------------------------------------------------------------------------------------
B. Quality. Currently, downloaded films are
viewed right on the computer screen, and there is a serious degradation of
quality compared to theaters or even video. Two recent developments are changing
this, however. The first is that Microsoft recently introduced software that
permits playback of downloaded films at thirty frames per second, comparable to
VCR tapes played on TV sets. The second development is technology permitting
downloaded films to be replayed directly on television sets, as opposed to on
computer screens.
--------------------------------------------------------------------------------------------------------------------------------------------------
C. Piracy. The fear abounds that once a film
is out there in the digital world, where perfect copies can be made over and
over, rampant piracy will occur. There are two answers to this problem: The
first is: So what? The studios have long ago accepted piracy as an unfortunate
but acceptable cost of doing business. They crossed this bridge with video, they
crossed this bridge with DVD, and they will cross it with Internet distribution.
The second answer is that technology has been and will be developed that
prevents downloaded films from being able to be re-transmitted to third parties.
A dream? Hardly. In April, a company called Sightsound distributed Artisan's
film "Pi" over the Internet for $2.95. With the use of high-speed
download technology, the film could be downloaded in about twenty minutes. Using
Microsoft's software, the film could be played back at almost VCR quality.
Sightsound claims to have patented technology that prevents the piracy of films
once downloaded. Other companies have entered the fray, including Reel.com,
Broadcast.com, Global Media, Inc., Reel Networks, and Shortbuzz.com.
--------------------------------------------------------------------------------------------------------------------------------------------------
III. Business Model
A. Distribution. The most likely scenario is
that studios will distribute their own films through their own servers, rather
than licensing their films to third-party servers. This model seems likely for
several reasons: First, it will permit the studios to maintain control over
their film libraries, rather than risk losing control, particularly in the
easily pirated digital format. Second, distribution costs will be relatively low
(other than advertising, which the studios already know how to do); it will not
require an extensive staff of employees, such as is required to service
theatrical or video distribution. Finally, it gives the studios direct contact
with the consumers, giving them the opportunity to cross-sell other films or
media. The main benefit of the Internet is to give companies direct access to
consumers, and the studios will not relinquish this benefit lightly.
It also seems likely that several of the studios may combine resources in a
joint venture, analogous to UIP (for theatrical distribution) or CIC (for
video). In this manner, consumers could hook-up with one server and obtain the
vast majority of potential films.
--------------------------------------------------------------------------------------------------------------------------------------------------
B. Window.
Initially, the Internet window will probably come after the video and pay-TV
window, and before the free TV window. Those two windows are too well entrenched
to permit being preempted lightly. In time, however, the Internet window should
cannibalize both pay-TV and video, effectively moving up the Internet window to
occur shortly after the theatrical release, analogous to the current video
window.
It is highly unlikely, however, that Internet distribution will ever replace the
primacy of the theatrical release. Just as video, pay-TV, television, DVD, etc.,
have not spelled the demise of theatrical, neither will Internet distribution.
People -- particularly teenagers -- like to get out of the house, and it is
difficult for any home system to compete with the large screen and multi-channel
sound system of a theater.
--------------------------------------------------------------------------------------------------------------------------------------------------
C. Pricing. The per-film pricing for
Internet distribution must drop compared to the video and DVD rental business.
This is because there are no manufacturing costs associated with Internet
distribution, and the distribution costs are far less. This substantial drop in
costs can only correlate to lower pricing. It is also likely that in addition
to, or in lieu of, a per/film fee, consumers could pay a monthly fee to have up
to a specified number of films per month. The server should also be able to earn
ad revenues through advertising, banners, and links to other Internet sites.
--------------------------------------------------------------------------------------------------------------------------------------------------
IV. Issues
A. Who Owns It? The immediate issue will be: Who owns Internet rights? The
disputes will include whether the producers granted the studios Internet rights
in the first place, and whether the studios have licensed those rights to third
parties. The answer will depend on the terms of each contract, and this issue
will be endlessly litigated. Since Internet rights will cannibalize both video
and pay-TV, one can expect the argument to be made that Internet rights come
within the definition one or both of those rights. In the author's opinion, it
is inappropriate to do so; it just cannot be said to be within anyone's
reasonable expectations that "video" or "pay television"
would include a media as novel and different as Internet rights. A more
problematic issue is whether Internet rights fall within the definition of
"video on demand" or "near video on demand" - definitions
that have been used for some time in contemplation of unlimited at-will access
to films. The difficulty is that it was generally contemplated that such access
would be via cable or satellite, so it really will depend on the precise
definitional language used. The simplest case is a future media clause, covering
distribution by "all media, whether now known or hereafter devised."
Whoever owns these rights should certainly own Internet rights.
--------------------------------------------------------------------------------------------------------------------------------------------------
B. Territoriality. Territoriality will be
the single most problematic aspect of licensing Internet rights. Under current
distribution models, most distribution rights are ultimately handled by
different distributors on a territory-by-territory basis. For example, a German
distributor may be licensed certain rights within Germany, and a French
distributor may be licensed certain rights within France. Each distributor then
distributes the film within its own country, and there are elaborate
restrictions on inadvertent distribution outside of the prescribed territory,
including terrestrial and satellite broadcast restrictions. All of this suffers
the fate of the stone axe under Internet distribution because consumers in any
part of the world can hook-up to a server located anywhere else. Unless caution
is used, a licensee of Zimbabwe rights could set up a server permitting
worldwide access to the film. Because of this risk, one solution is for both the
licensor and licensee to "freeze" Internet rights until technology is
developed and used that limits Internet access to within a proscribed country or
territory. For example, technology may be developed limiting access to phone
numbers starting with a certain prefix (although call forwarding may defeat
this). The most likely solution is that Internet rights will be left with the
licensor (typically a studio), and perhaps the licensor will be required to pay
the licensee for revenues attributable to Internet access within the licensed
territory. For example, it may become possible to source revenues within that
territory based on phone number prefixes, or perhaps some specified percentage
of worldwide revenues can be used.
Another approach is to license Internet rights, but to require the Internet
version used by the licensee to be dubbed into the home language. This is
similar to what is currently done for satellite broadcasts (unless they are
encrypted for reception within the home territory). It is unlikely that
requiring only subtitling will be sufficient if the film is still in English, as
subtitling in a foreign language would not be an effective block against
consumers who speak or understand English and are willing to ignore the
subtitles.
--------------------------------------------------------------------------------------------------------------------------------------------------
C. Holdbacks. The resolution of determining
the appropriate holdback for Internet rights will depend on where the Internet
window falls, discussed above. As discussed there, one might expect Internet
rights to initially be subject to a holdback until after the video and pay-TV
window, with this holdback subsequently moving up to replace the video and
pay-TV windows entirely.
--------------------------------------------------------------------------------------------------------------------------------------------------
D. Calculating Contingent Payments
to Talent and Licensors. One of the wonderful battles will be over the
calculation of participations owed to talent and overages owed to licensors. The
resolution of this issue will depend on the business model used for Internet
distribution. As discussed above, it is likely that the studios will undertake
Internet distribution directly or through a multi-studio joint venture. In this
case, the immediate question is what revenues constitute "gross
receipts" as the starting point for calculating contingent payments. Talent
and other payees will obviously take the position that revenues received by the
server from consumers should constitute gross receipts. It can be predicted with
absolute certainty that the studios will take the position that these revenues
must be excluded, and that gross receipts must start with a deemed royalty paid
by the server to the studio. For example, the studios still generally get away
with including in gross receipts a deemed royalty as low as 20% on video
revenues, and video revenues never include payments by the consumers, even if
the studio owns the retailer (e.g., Blockbuster). Similarly, when Disney
licenses films to ABC, its wholly owned network, only the revenues received by
Disney, not ABC, are included in gross receipts.
If the studios prevail in adopting a similar inter-company deemed royalty model
for Internet distribution, the remaining question is what the inter-company
price will be. Presumably, it will be stated as a percentage of server revenues,
and one can expect the studios' opening bid to be 20% (after all, they generally
get away with this on video). In lieu of a percentage of gross receipts to the
server, another model may be an arbitrary price, to some extent based on
theatrical receipts, which is basically how inter-company sales to television
networks are done.
Another issue will be what distribution fee, if any, applies to Internet gross
receipts. If gross receipts are calculated at the server level, then it seems
fair to have a distribution fee, albeit a low one, because distribution
activities should be relatively modest. If, however, gross receipts are
calculated based on a deemed royalty to the studio, then there should be no
distribution fee, just as there should be no distribution fee on a deemed video
royalty (unless the contract is really piggish).
The next issue will be what, if any, distribution costs are deductible. Again,
if gross receipts are based on gross receipts to the server, then it is
appropriate to deduct all actual costs incurred in connection with Internet
distribution. If, however, gross receipts are calculated based on a deemed
royalty to the studio, then no distribution costs should be deductible on the
grounds that the royalty percentage is in lieu of all costs. For example, this
is how video is typically handled. On this point, someone should argue that a
large portion of theatrical advertising costs are intended to benefit Internet
distribution, and so should not be deductible. (However, this same issue applies
to the current calculation of video net receipts, and the author is not aware of
anyone winning this argument . . .yet.)
A further complication will be how to allocate revenues among pictures,
particularly if consumers pay a monthly subscription price in lieu of a per/film
price. This same issue currently applies to any package sale of film rights, and
the best that can typically be achieved is vague "fair and reasonable"
allocation language in the contract.
Finally, you can be sure that, one way or another, ad revenue received by the
server will not be included in gross receipts. If server income is included in
gross receipts, there will most likely be a blanket exclusion for ad revenue.
Alternatively, the very existence of ad revenue will be an argument as to why
gross receipts must be calculated based on a deemed royalty to the studio, as in
the case of an affiliated television network.
All of these issues will be particularly fun in the context of contracts that do
not contemplate Internet distribution. The studios will most likely resort to
self-help in the form of forming the server as a separate company and entering
into a formal inter-company license. The interesting issue will be if the
contract in question picks up revenues received by affiliates or refers to
"at-source" accounting.
--------------------------------------------------------------------------------------------------------------------------------------------------
E. Guild Residuals.
Another problematic issue will be determining how to calculate guild residuals
on Internet revenue. Similar to the question of calculating contingent payments
owed to talent and licensors, the question under the guild agreements is what
will be the starting point for calculating gross receipts. Until the guild
agreements are amended to expressly deal with this question, the same battles
discussed above in connection with calculating participations and other
contingent payments owed to third parties will apply in calculating guild
residuals. But just where do Internet revenues fall under the current guild
agreements, which currently divide film revenues into theatrical, video, pay-TV,
and free-TV? Perhaps the answer is, "Nowhere."
--------------------------------------------------------------------------------------------------------------------------------------------------
V. Conclusion
The ability of consumers to pay to see a film of their choice at any time will
have profound implications on the film industry. At a minimum, the value of film
libraries should skyrocket, just as they did with the introduction of video. It
will take years to sort out the business and legal implications of the new
distribution pattern, and lawyers will have their hands full negotiating and
drafting contracts that properly deal with the issues - or litigating those that
don't.
--------------------------------------------------------------------------------------------------------------------------------------------------
DISCLAIMER: This discussion is general in nature and is not intended to
and does not create a lawyer/client relationship. This discussion should in no
way be relied upon or construed as legal advice, particularly since most legal
outcomes are highly dependent on the facts of a particular case or situation.
This discussion is provided on the condition that it cannot be referred to or
quoted in any legal proceeding; if this condition is unacceptable to you,
immediately delete this email and do not keep a copy of it in any form. The
reader or recipient is strongly urged to consult with a lawyer for legal advice
on these matters. Any reliance on the discussion information by someone who has
not entered into a written retainer agreement with the lawyer providing the
discussion information is at the reader's or recipient's own risk.
|
