Sagansky Moment – The cult of profit sharing serves the powerful at the expense of creators.
In June 2022, at an event promoted by NAPTE (National Association of Television Program Executives), influential TV producer and investor Jeff Saganky addressed his peers to great repercussion. He protested in strong terms against the business model adopted by big streaming platforms when commissioning new content for their catalogs.
Sagansky’s outrage was directed at the (almost exclusive) preference of those big players for cost-plus deals (also known as buyout deals) to the detriment of traditional backend deals practiced for decades in media markets, which include profit share with production companies and artists (screenwriters, directors & main cast) also known as “above the line” caches (because they are the largest caches and are usually hired at a fixed price, regardless of the number of working days).
Sagansky argues that purchase agreements practiced by the platforms will cause that content to be “licensed, relicensed and watched in every corner of the world in the way digital revolution made possible”, while creators and producers “are paid only once, upfront, 10 or 20% more than your normal producer rate and would never be paid for all those billions of views, all this relicensing revenue, all that embedded advertising revenue.”
To better understand this debate, let’s start by defining the elements at stake:
Audiovisual contents are copyrighted works of art, but the path from the idea to the finished product is long and takes lots of money to become valuable intellectual property. Therefore, it usually begins as a project, made of storylines, film scripts, and series bibles (the artistic and creative part of the project) but also plans for its production (budgets, production designs, deals with talent, etc.). This first move is the development phase, and during that time, the material goes around a market that is invisible to the ordinary consumer of films e TV shows: the project market. There, authors present their ideas, generally to producers. If interested, the producer will invest in development and planning to present that properly developed project to content aggregators. These are big companies that finance the production and then sell all those films and series to the consumer market. The kind of friction exposed by Jeff Saganky happens precisely in that project market.
The typical path through the project market means the initiative is up primarily to the artist and then the producer. Finally, it is up to the aggregator to receive proposals and select those that will get financed. There are variations like when the aggregator orders the artist to create a specific product and then hires a producer to execute it. This second case is straight-forward commissioning while the first is called Spec (short for speculative) because it is a project created without a promise of purchase. Therefore it is a speculative project.
There are two components in every negotiation around producing a spec project: rights and services. Different professionals and companies involved in the project are compensated because they have intellectual property rights, but also because they perform their work while building that same property. A screenwriter, for instance, takes payment to concede production rights on her writing, but also receives to provide her services (actually writing). The same applies to the producing company. The producer can charge a fee for broadcast rights, but also get paid for production services. In practice, these two revenues get mixed up and this is precisely what causes much of the conflicts we now see.
From a rights and property standpoint, it all comes down to the original copyrights. Those belong to the author and will be kept that way. Authorship cannot be sold because it is a fact, not an asset. But you can sell copyrights, for instance, when the author licenses the rights to make a film from his script to the producer. Afterward, the producer can make a deal with an aggregator for the rights to show that film. In every case, it is the concession of rights that drives the original idea through the path to become real. Every new partner that joins the project deserves to be rewarded for efforts in taking it forward. There are only two possible ways to compensate these stakeholders: directly paying for their service or making them partners in the project, with equity on future revenues, if they ever come. The project development rule of thumb is simple: if you have the money hire the services, if you don’t, share property rights.
A cost-plus deal is an agreement in which the producer is paid for all expenses on the making of the proposed project, plus an added amount for his profit called the premium. This agreement between producers and content aggregators is often called a “buyout”. That is a word borrowed from the financial market and refers to cases when an investor acquires a majority or total part in an enterprise resulting in the loss of management control by the invested party. The bottom line, the investor buys the current controllers out of the business. What is the investor buying? Property rights. In this case, intellectual property rights. That doesn’t necessarily mean that producers and talent will not play their roles in production or be paid for their services. What happens is they don’t have ownership kind of control anymore. This means they’ve given up the final say in artistic and commercial decisions for that project. In theory, the aggregator could even fire them (if the deal doesn’t prevent that) and give the project to be rewritten, produced, and directed by third parties.
The backend deal is a different kind of agreement in which the aggregator invests in the production of the project but acquires a limited part of property rights to the project. In that type of agreement, the aggregator becomes more of an additional partner in the business. The producer and even the talent will live up to equity on revenues in the future. Of course, the backend deal happens when aggregator investment does not cover total costs for the development and production. In that case, it is up to the producer to bear the remaining costs.
To fully understand what the differences between these two business models mean, we will rely on the concept of “deferral”. The term is common in accounting and refers to a trade-in time. In short, it is the payment in advance for a good or service that will be delivered at some point in the future. This future item is a “deferred asset” which makes its cost not to be considered an expense.
What drives someone to pay upfront for an asset that is not yet bringing benefit? The answer to that question lies in yet another financial term: “arbitrage”. This means speculating on the difference between the future value and the present value of a market asset. Using deferral, those who pay in advance are making an arbitrage, betting on a higher gain in the future for what is being acquired now. More simply, you pay upfront when you get a discount, that is when you believe you’re paying less now than you would pay afterward. Companies use deferral when they think there is no better use for their available cash now than to take advantage of the discount that can be obtained by paying upfront. In the case of cost-plusagreements, it is no different. The aggregator is paying upfront while making an arbitrage between that amount and the value that equities would probably have in the future. In backend agreements, it is the producer and talent that give up present revenue in favor of future equity and we certainly hope that they do it by carefully calculated risk arbitrage.
A company that makes arbitrage, speculates and therefore takes risks. When the aggregator pays upfront for the producer’s profits and full costs for above-the-line talent, it risks increasing its loss if that content flops. The same for the producer or talent that prefers profit sharing rather than upfront payment and takes the risks of failure on themselves.
The difference between these two business models is therefore a question of calculated risk-return ratio in the present and the future. As the folklore says, it is about quitting certainty (present value) for hope (future value). Of course, the future value is unknown, which is precisely why we call it a risk. Arbitrage must be undertaken to bring uncertain future value to a certain present value. You do this by applying a discount rate, at least equivalent to the compound market interest that would be obtained between now and that future moment.
Now that we properly established the structural elements for the underlying rationale for those business models, let’s proceed with the mapping of possible motivations each market player could have in this dispute.
It would not be wise to limit our examination to strict matters of finance and accounting. There are other properties of agents’ activity that could influence their preferences. For the big streamers, the backend-deal model brings operational drawbacks. TV Channels and film distributors operate within strict geographic boundaries. For these companies, it is not worth paying for licensing rights that cover territories beyond their reach. For producers, it is valuable to keep their ability to independently negotiate other territories. In this case, contracts that hand some commercial control to the producers serve both parties’ purposes. The same cannot be said of global video-on-demand operators. Excluding territories from the agreement would hurt their overall strategy. Moreover, the very nature of their portfolio (an unlimited catalog) makes a limited duration license not as attractive as it is to a film distributor. Distribution companies have no use for a film after a few weeks or months of its premiere. Finally, TV channels perform content licensing work including the syndication to affiliated companies, even when they are part of global media groups with brand ownership at stake. Big media is more complex and much less monolithic than people generally think. When that model is in the play, it makes sense to compensate the producer and talent pari passu. But that logic does not apply to streaming.
That said, it is worth asking what exactly those future revenues are, as claimed by Sagansky, that could yield income outside the streamer’s ecosystem. In the case of subscription services, recurrent revenues are diluted throughout the catalog and could not be easily attributed to a specific title, so that due compensation could be handed periodically. In transactional services, the consumer pays for a specific product, but the revenue-share model is already widely adopted in that environment. The only other way a producer could have ancillary revenue in that kind of business model would be through the expiring of a specified period but that would be a broadcast license, not a production deal. Sagansky’s reasoning leaves hints of a more specific vision when he suggests the resurrection of the 1970s regulatory rule known as the Financial Interest and Syndication Rule (fin-syn). Fin-syn rules were designed to curb what he calls “coercive anticompetitive behavior”. According to him, thanks to that regulation, the next forty years were a golden age of producer’s ownership”.
To better understand the implications of this suggestion, let’s revise what we know about the industry’s history of disputes over business structures. The topic isn’t all new, nor it is the business model adopted by the online video platforms. In the 1970s, the U.S. media market underwent radical economic rearrangement. Regulation changes like the Financial Interest and Syndication Rule were part of that. From the point of view of yet to be dominant producers’ that shift has resulted in the predominance of independent cinema, which became to be known as New Hollywood, as opposed to the Studio System.
Of course, independent cinema existed long before that. In the US it had Charlie Chaplin’s United Artists as its greatest symbol. In Europe, the vicissitudes of war gave birth to a way of producing films very different from the Studio System model. Filming on location with lean teams leads by the new iconic figure: the auteur director. This highly politicized strand defined the aesthetics of cinema in the second half of the 20th century, including aesthetically radical movements such as Italian neorealism and Brazilian Cinema Novo.
The Fin-Syn Rule was a regulation created as a reaction to a similar phenomenon to what we are experiencing today. By the end of the 1960s, TV was barely related to cinema due to technological limitations. Lacking electronic recording media and plagued with low-quality of image and sound, TV was still exclusively live media, much more of radio with images than a home cinema as we see it today. With the advent of videotape recording and the improvement of technical conditions, all that changed. A few years later, TV not only became a vehicle for showing films but also engaged in the production of recorded & edited content, a model very similar to that of the film industry. Film talent went working for major U.S. TV networks (ABC, CBS, NBC) but soon came across a different business model entirely. One that they were not at all prepared to face. Major TV networks were highly capitalized by stable cash flows from major advertising contracts. They were not exposed to revenue volatility caused by the vagaries of the theatre audiences like film studios. In addition, they were vertically integrated companies, accustomed to having full control over the product, from conception to the end of its market life cycle. Again, very different from the studios, which have abandoned their verticalized structures after the Paramount Cases. The latter, which took place in 1948, was also a major regulatory event that prevented studios from controlling movie theater companies. These two factors encouraged studios to share risk and profits with producers and other partners. On the other hand, the same issues stimulated cash-loaded TV to simplify business and take 100% of production costs, absorbing all the risk but also retaining the entirety of subsequent revenues.
Now we met the heart of the matter. The fact is big producers were not fond of the model imposed by TV networks, just like they are now raging against the model imposed by digital platforms, going so far as to litigate on the subject asking for state intervention. The rebellion resulted in the rise of fin-syn rules, imposed in 1970 by the Federal Communications Commission (FCC). The rules aimed to avoid oligopoly and tried to do so by preventing television networks to keep property rights of prime-time broadcasted programming content. TV was limited to paying for a broadcast license for a limited period.
Many argue that Fin-Syn rules were responsible for the so-called golden age in independent television production. Others argue that the rules made it difficult for independent producers to access the TV market because smaller companies, lacking other sources of financing other than the networks, could not structure new productions.
Fin-syn regulation generated controversy, while it lasted. Ten years after its implementation the rules were gradually relaxed during the 1980s. When it was officially abolished, in 1993, fin-syn was already rendered into disuse. It didn’t take long before film studios entered the TV business and the market converged. Now multiple channel programming was made possible by cable TV, solving the limitation on VHF/UHF radiofrequency spectrum.
History teaches us the remarkable development of the U.S. media industry has always been marked by cycles of regulation and deregulation. In periods of deregulation, incumbent companies capitalize notably. If all goes well, gross capital formation happens, that is, an effective increase in infrastructure and the overall capacity to create more content and services. As a result usually, a large concentration of power and income causes discontent, fueling conflict between different links in the production chain. As consequence, a new cycle of regulation occurs. But are the internal dynamics of resource distribution the only cause of these waves?
As we saw earlier, the adopted business model for financing original content in each period is determined by risk and return calculation. Therefore, we have three interdependent variables for this calculation.
The first variable is the risk of loss of invested capital. When the risk is too high, a company will prefer to share it with others. The risk of investing in new content is always high because competition is huge and the reaction of audiences is unpredictable. The mere existence of large conglomerates of film, TV, and Streaming means nothing more than a strategy for risk dilution: diversifying content catalog into ever larger portfolios. That’s why these market players are known as aggregators. That’s exactly what they do: aggregate content and dilute risk. Small aggregators are at greater risk, so they will give preference to agreements in which costs (and consequently profits) are shared with partners, including producers and talent. If all goes well, everyone will be happy. If it goes wrong, no one’s going to go bankrupt from it. On the other hand, large aggregators have their risks diluted and can afford to take it on themselves alone. Their bet is pocketing 100% of profits in a few hits will compensate for losses on many flops.
The second variable is the return on investment, and it is directly connected to the first. When expectations on the return are high (for example, because the new content is derived from a successful franchise), the availability of capital risk increases. That’s why companies like Disney shell out billions of dollars to acquire entire fictional universes like Star Wars or Marvel. This capital could finance hundreds of original productions, but the high expectation of return from these brands and the high risk of trying to create something similar from scratch make those billions seem like a safer investment than a few tens of millions in ideas never tested. Therefore, when return expectations are low, risk disposition is also low, and the preferred business model will be that of sharing costs and equity.
The third and final variable is the availability of capital itself. First, because the volume and capital flow determine the degree of risk dilution that an aggregator can achieve. When TV channels and digital video platforms acquire advertising or subscription consumers, the future flow of money to pay for their commitments gets more predictable. As much as these inflows may vary, this happens if much less volatility than it does for a film distribution company. A small TV channel has a limited volume, but still, it has an expected flow of income (at least medium term) and it simplifies risk-return calculations. In the risky world of the cultural industry, it is better to have limited but reliable revenues than big but uncertain release projections.
But capital availability depends on more than microeconomic factors. The downfall of the Bretton Woods Agreement meant the end of gold backing that gave the dollar global reserve currency status. Since then, we live in a world economy progressively fueled by never-before-seen monetary expansion, created by U.S. Federal Reserve, especially after the 2008 financial crisis.
The expansion of the monetary base translates back into negative interest rates, i.e. lower than inflation. This means that, in such an environment, it is more attractive to lend or invest (even at risk) than it is to save money in the form of cash or government bonds. This reality is decisive not only in the American market but also in other countries, influenced by it despite local interest rates or inflation. This happens is because the American economy is still the world’s locomotive, and its currency is the global benchmark for pricing value. If this is true for the economy in general, it is even so for the global media and entertainment market, where American power is felt in full.
Such a supply of cheap money should, according to the most accepted economic theory, immediately result in high inflation rates. However, for several reasons (much discussed in the context of macroeconomics, but which do not concern this discussion), the inflationary outbreak took longer than expected and presented itself only in early 2022. That means we have gone through some 15 years of low inflation with negative interest rates, a sui generis scenario, which served as fertile ground for the financing of all kinds of extravagant ventures. Examples swarm, from WeWork and Theranos to a recent case in the streaming market: Quibi, which raised $1 billion in 2018, promising a revolutionary short video platform for smartphone users, died in 2020, just six months after its launch, during the pandemic boom of streaming, without having managed to attract a significant number of subscribers.
All major online video platforms have been created and grown in such an environment. It’s been an alternative reality in which even explosive growth rates are eclipsed by the massive scale of financial leverage that sustains it. Virtually none of the major US-based video providers reported a profit for over a decade and a half of IPOs, credit taking, and billion-dollar investments in original content.
What does that mean for risk-return calculations on these companies when they plan on investing in more content? The answer can simply be found by articulating the three variables presented before. Potential risks and expected returns, although relevant in the microcosm of project selection processes are, in practice, eclipsed by the seductive metric of a seemingly infinite stock of financial ammunition to face competitors with the same level of capital flow and access. The streaming market has been turned into an arms race where the advantage is on the prodigal side, serving a cash-burning machine based on irrationally optimistic projections.
U.S. platforms totaled $200 billion in investments in the development and production of original content in 2020. It is natural to see that these aggregators are not interested in contract models other than the full acquisition of rights. That strategy allows these companies to turn low-value money (remember negative interest) into assets using the gimmick of abusive arbitrage. The content contracted today at a discount remunerates (at least from an accounting point of view) over the pricing thanks to negative interest at the same time it increases the denominator for dilution of portfolio risk.
Considering the widely known fact that most films and TV content never break even, we have to ask: why would a producer (like Sagansky) who has very limited capacity to diversify product portfolio, would prefer to forgo immediate revenue (the premium paid in a cost-plus deal) in favor of some theoretical future revenue (profit sharing in case of success)?
Some hypotheses can be enumerated based on those same three variables already mentioned:
Risk: it could be the case that, in a backend deal, the producer would take profits in case of success, but would not take losses in case of failure.
Return: the producer is convinced that the project profits will surpass the premium paid by the aggregator.
Capital: The producer has easy and cheap access to the complementary capital that would be necessary for him to finance his part of the project.
Let’s take a closer look at each of them:
Risk: in the case of above-the-line talent (director, cast, writer) it is common to convert part of the nominal payment value into profit share. In that case, capital is indirectly invested by the talent in production, in the form of a discount. This arrangement has several advantages for talent. First, most productions would not be able to pay in full, therefore the choice to receive a viable amount, plus equity, is second best and certainly better than not getting the job. Second, considering that most projects do not make it to break even, talent preserves nominal pricing at a higher level, at no cost to the producer, and can use this “virtual” value as a parameter in future negotiations. In the case of producers themselves, it is rare to participate in results without bringing financing more concretely. The exception is the case of contributions made by third parties on behalf of the producer with no collateral, as is the case in some types of government-backed financing.
Return: every artist believes in the potential of their creation, but most professionals in the industry know that results are quite uncertain. There are only two types of producer or talent that could rationally bet on equity over price: one that holds rights to an already successful brand or one that has great market connections, to the point of ensuring sales in ancillary markets even in the case of a mediocre or failed product. In both cases, there is a bigger problem than the share rate of revenue: the premium for an acquisition, that is, the discount rate applied to bring potential revenues to present value.
Capital: it is rare for a producer to have the same ease of access to financing as an aggregator. In the case of smaller producers that happens only if the contribution is made by third parties without expectation of return, as is the case in governmental financing.
The above exercise allows us to divide a common element into different hypotheses. In all cases, we are talking about a tiny minority among talents and producers. These chosen few would be worth fighting for revenue share. But for the vast majority of creators and producers, who are not beneficiaries of those possibilities, a Cost-Plus dealis the best possible arrangement due to the circumstances of a highly competitive market, congested by a multitude of bidders and few visibility alternatives.
Jeff Sagansky, the central character in the current discussion, represents perfectly that privileged minority. He is an extremely influential producer and investor, and former president of industry gigs such as Sony Pictures, CBS, and TriStar Pictures. A part of the executive’s speech at the NATPE event draws attention, as it gives a precious clue of what is at stake in the dispute. In his argument, Sagansky complains, saying that the first cost plus contracts proposed by the streamings included “huge buyout premiums that may have in some cases come close to approximating the backends for some hit shows, my prediction — and we are seeing it now — is that these buyout premiums are coming down dramatically, and I further predict that these big deals given to the brand name producers will also disappear as the streamers consolidate and the competitive environment coalesces around 3 or 4 big services”. Note that the real dispute here is between major producers (which he calls “brand name producers”) as to the value of premium in purchase contracts that, according to him, begin to show the first signs of flattening. The reason for the dispute is not the business model or the acknowledgment of creative talent, but pure and simple pricing models.
That said, what would be the cause of this flattening of premium? There are only two possibilities:
Expected returns are lower, suggesting more pessimistic revenue projections from aggregators.
The risk and discount rate are higher, suggesting a change in the financing environment.
Lower return projections, generally applied to a broad content portfolio, cannot be explained by any assessment of development market potential. It should be something systemic, affecting the returns of large services funded by advertising or subscription. This means one thing: companies expect an economic recession in their addressable markets.
Higher discount rates when calculating the internal rate of return on investments for content reflect a new reality in a market environment: high-interest rates that consequently increase the cost of capital and significantly alter the calculation of opportunity cost in asset allocation.
These factors demonstrate the cycles of the macroeconomic environment may have a greater influence on the internal dynamics of the industry than some would suppose. The intensification of conflicts between players in the industry leads to a chain of events that sometimes culminates in the adoption of restrictive regulatory policies. The initial cause for such conflicts frequently points to changes in the macroeconomic scenarios and should not be underestimated.
To test this hypothesis, let’s revisit two moments of regulatory tightening mentioned earlier. We will do it in the light of two macroeconomic indicators of undeniable impact on the E&M industry: interest rates and price index (inflation).
The chart below shows the evolution of interest rates in the U.S. between 1800 and 2016, which included the 1948 decision by the U.S. Supreme Court forcing major studios to abandon their theatrical operations (Paramount Cases). This lawsuit occurred in the wake of a series of conflicts and disputes between companies in the industry and the decision came out in the third year of a monetary contraction scenario that followed after FED rates had reached all-time lows in 1946 (after 25 years of falls). The previous 10 years saw rapid reductions in interest rates. This monetary stimulus helped finance the expansion of the Studio System. The interruption of this expansion process and consequent credit restriction led the major studios to adopt increasingly aggressive deals with theatres, such as Block Booking (programming of film packages with no chance for picking titles) and Blind Booking (programming of a predefined number of titles before they were known to the exhibitor). As a result, a legal battle and consequent regulation by the supreme court’s binding decision. Our current scenario is similar. After 40 years of falling interest rates, the inflationary scenario in 2022 forces the FED to raise rates. This turn of the tides, which shall cause a recession, puts pressure on market agents’ business models, therefore causing conflict and demands for regulation.
The next chart shows the evolution of U.S. interest rates between 1950 and 2021, in which we included the creation of fin-syn regulation in 1970. The gray bands indicate periods of recession. Note that regulation came during a recession, after an acute rise in interest rates in previous years. These moments of recession cause a conflicted environment for the industry and result in intervention by the government. Fin-Syn’s standards began to be relaxed in the early 1980s, another period of recession with interest rates at historic highs. Adverse economic circumstances have put TV networks in such difficulty that it was in the interest of the industry as a whole to loosen restrictions to give commercial alternatives to market players.
Finally, as counterproof, let’s experiment with those events now on the historical graph for inflation rates between 1944 and 2022. Note that the Paramount cases occurred at a time when the authorities were fighting an inflationary outbreak after the end of WWII. In 1948, after a sharp dive in rates, you see an inflationary spike, resulting in stronger monetary tightening. 1970, the year fin-syn regulation was introduced, marks yet another inflationary peak, the same for the disassembly of this regulation in the early 1980s.
Data seem to reinforce that perceived correlation between more intense disputes between players (along with pressure for more regulation) and those moments of macroeconomic stress that hider the aggregators’ ability to leverage capital.
It seems correct to state today we are living in one of these moments. After years of particularly low-interest rates, a stagflation scenario radically changes the prospects for growth and financial balance by today’s E&M incumbents and their streaming services. Those players got used to a business model with no risk and revenue sharing. As for, they must reduce premiums on their deals, which leads to discontent, initially by privileged producers. In the end, a major call for external intervention takes place. We might wonder why aggregators would not simply adopt the well-established backend deal model, giving producers what they want while reducing their risks. This move is perfectly possible, and it would not be surprising to see big producers getting exactly what they asked for, but for reasons more bitter than they wished for. However, as said, the operational constraints of the streamers create major obstacles to the adoption of that model.
In the financial market, there’s this expression, “Minsky Moment”, which refers to the starting point of a sudden and important collapse in the value of financial assets, pointing to the end of a cycle in credit and trade. That moment has its analog for the content industry. The point when the lights go off, fingers are pointed, and cracks start to show on the links of the economic chain. Let us, therefore, baptize this tipping point by honoring the character of the moment as we’re living a Sagansky Moment.
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