Disney wants to be Netflix, yet the new contracts for stars and producers are causing entertainment lawyers to question which platforms are better for profit participants, writes a top attorney.
Profit participation in the TV industry was born in the 1960s, when studios and independent production companies dominated prime time at the three networks. The definition of “profits” for creative talent working on scripted series has since evolved. In those early days, the production company owner of a show would simply charge large distribution fees (typically 30 percent to 40 percent) and overhead fees (15 percent to 20 percent), which prevented stars, creators and virtually all potential profit participants from reaching defined profitability.
Then, in the ’80s, the pendulum swung in favor of talent. A top writer-producer would go to one of the broadcast networks, secure production commitments for a pilot or series and then turn to a studio for financing and distribution. Talent would even enjoy the benefit of the Investment Tax Credit, which sheltered much of the production income. In those times, talent could negotiate for the elimination of almost all distribution fees and cap overhead charges so that, on a successful series, they would be paid around the same time the studio achieved actual profitability.
Then the ITC was abolished, and Fox decided to go into the broadcast business. A three-plus-year battle between the studios and networks ended in 1993 with the Federal Communications Commission and the Department of Justice knocking out the Fin-Syn rules, which had prohibited broadcasters from owning or distributing their shows. That triggered a burst of M&A activity, resulting in several media giants. They charged distribution fees (10 percent to 20 percent) on off-net exploitation, and overhead fees (10 percent to 15 percent) on production costs and began to license their shows to affiliated entities (like Fox putting reruns on its FX channel), even when a competitive market would bring in more dollars and, arguably, viewers. This met resistance, which resulted in a concept called the Imputed License Fee. If agreed upon by the participants, it permits the producer/distributor/exhibitor to assign fixed amounts or formulas, effectively “imputing” income rather than requiring the entity to maximize gross receipts. The resulting profit participations, called “MAGR” (modified, adjusted gross receipts), are now employed by virtually all major studios, especially those that operate (or are about to operate) digital platforms like Hulu or Disney+.
Yet another significant shift in how talent is paid came in the 2010s, when new entrants from Silicon Valley disrupted the ecosystem. These entities — Netflix and Amazon Prime as paradigms — made the costly decision to go after A-list talent with a radically different pay structure. First, they made clear that — unlike the major studios — any scripted programs they developed and financed would be exhibited exclusively on their own platforms in perpetuity. The notion of traditional tiered distribution in the linear world would cease in favor of direct-to-consumer for digital, coupled with an imputed license fee. Second, they were willing to pay talent generously “up front.” Instead of contracting with top hyphenates for a yearly guarantee of seven figures, they would actually commit to an eight-figure guarantee per year. In return, instead of an open-ended backend deal that depended on how much the rights holder could obtain from unaffiliated downstream outlets, formulas were trotted out so the talent would be “bought out” for a fixed sum. And, to the chagrin of the cognoscenti, the buyout bonuses were not necessarily based on performance.
Just as the Silicon Valley entrants were attracting more and more subscribers with a “binge” release model, star-studded programming and easy-to-manage user interfaces, there was a corresponding loss for linear channels. Domestic ratings fell like a rock on broadcast networks, basic cable and even premium pay outlets. The issue had to be addressed: Would (or could) the vertically integrated media giants dare to compete with Silicon Valley? And if so, how? What approach might they adopt in dealing with talent?
Today, as we see spending on premium scripted content — both in production and marketing — rapidly accelerate, there has been a pronounced shift in business models from linear to on-demand; the result thus far has been a race to the bottom for profit margins and free cash flow generation. Will the media giants treat profit participants in the same manner as the giant digital companies?
It is not a surprise that each vertically integrated media giant has chosen a different path.