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When Will Cinema Go Digital?

(originally published by Booz & Company)

With the May 2002 release of George Lucas’s Star Wars: Attack of the Clones, the spotlight is again focused on the promise of digital cinema. But, as in other areas of entertainment, the digital transition in cinema has not been smooth. A new Booz Allen Hamilton study suggests that full acceptance of digital by the film industry is only a distant possibility, unless key players can redefine how they share revenues and find creative ways to finance the multibillion-dollar cost of the changeover.

At least a half-dozen films shown at this year’s Cannes Film Festival were shot at least partially using this new technology, which stores video and audio as digital data so it can be manipulated and transmitted electronically. However, few moviegoers actually saw Mr. Lucas’s film in its pure digital form. Although Clones was shot digitally from beginning to end, and Mr. Lucas seemed as intent on spreading the word on the wonders of the new technology as he was on hyping his movie, when it opened in the U.S., only 60 screens out of 5,000 displayed it using digital projectors.

The problem is, the directors may be hooked on digital, but the studios and theater owners — the companies that would have to finance a new digital infrastructure — aren’t. Their argument? With 36,000 screens in the U.S., it could cost $5 billion to $7 billion to upgrade the entire infrastructure. Why undertake such a large and costly project when the current system works well in getting films produced, distributed, and exhibited to audiences around the world? Plus, in contrast to digital music, digital cinema cannot claim a customer base clamoring for it.

Proponents counter that this attitude ignores the flaws in an aging business model and underestimates the promise of digital cinema not only as an entertainment medium, but also as a way to significantly drive down costs and tap into new revenue streams. When a studio produces a movie, for example, it makes thousands of celluloid prints and ships them in metal canisters to theaters. In the U.S., it costs the studios more than $1 billion a year to duplicate, distribute, rejuvenate, redistribute, and dispose of the year’s film reels. With digital cinema, much of this cost to the studio would be eliminated because movies could be created, stored, distributed, and projected electronically.

Theaters, instead of being constrained by how many prints they have, could instantly access a digital movie through any projector linked to their server, and simultaneously increase the number of screens showing a film. Consequently, theaters would be filled closer to capacity more often, and revenue opportunities would increase.

Digital cinema also opens avenues for theaters to show new types of content, including preshow advertising and special presentations of live events, such as sporting events or concerts, which appear to be underexploited by the current distribution model. According to Booz Allen analysis, cinema advertising could generate between $400 million and $800 million in additional revenues annually for the U.S. theater industry.

Still, all of the potential economic advantages of digital cinema — close to $1 billion in additional revenue for theaters and $1 billion in cost savings for studios — are overshadowed by the estimated $5 billion to $7 billion it would take to upgrade the infrastructure, and the advantages don’t add up to enough to justify a complete switchover in a short period of time. In this industry, spending money without a quick payback is not part of the culture.

Studios face other obstacles. It is not yet clear which of the competing technological specifications will become the standard for digital cinema, and studios don’t want to risk backing the wrong approach. In addition, operating two different distribution systems for any period of time is not particularly palatable. And, most serious, studios fear that distributing their films over computer networks will lead to piracy.

Meanwhile, the revenue-sharing arrangement between the theater owners and the studios — an old business model that the studios don’t want to change — makes digital cinema much less desirable for the theaters. Currently, the largest percentage of revenues goes to the studios at the start of a run, declining about 10 percent each week after the opening. This means that if demand for a new film beats expectations, and theaters can use digital files to immediately show the film on more screens, studios will actually get a larger share of the increased revenues from new releases.

Moreover, the promise of additional revenue from advertising or other uses of the facilities, while attractive, is too speculative at a time when theater owners, facing the consequences of building too many cinemas in the 1990s, are scraping for cash to make interest payments on their real estate, or filing for bankruptcy.

The only hope for digital cinema may lie with the film distributors. These companies collect upward of $1 billion in fees per year to reproduce and disseminate celluloid prints to theaters. Traditional distributors, like Technicolor, as well as companies better known for electronic communications, such as Qualcomm and Boeing, view digital cinema as a potentially lucrative innovation that could cut the cost of distribution and open a new communications market. To test the waters, some are slowly infusing capital into the system. Technicolor recently announced a plan to fund 1,000 digital screens. And Boeing says it will soon have 40 systems in place worldwide that will use satellite technology to distribute films.

Distributors could invest in installation of digital cinema equipment in return for a share of incremental revenues for advertising and alternative content. They could also offer the studios reduced fees as an incentive for providing digital prints. In addition, distributors could syndicate advertising and alternative content, given their relationships with the full universe of theaters.

Michael S. Katz,
Michael S. Katz is a senior vice president with Booz Allen Hamilton in New York. He specializes in media and entertainment, information technology, and e-business, working with clients in traditional publishing, recorded music, interactive media, television, and motion pictures.

John B. Frelinghuysen,
John B. Frelinghuysen is a vice president with Booz Allen Hamilton in New York. He specializes in strategy development and implementation for clients in the media and entertainment industries, including TV networks and program suppliers, online destinations, business/professional information providers, major film studios, music companies, and site-based entertainment businesses.

G. Krishan Bhatia,
G. Krishan Bhatia is a senior associate with Booz Allen Hamilton in New York. He focuses on helping media and entertainment companies develop growth strategies and create value by leveraging digital technologies. Mr. Bhatia’s clients include many of the leading recorded music, filmed entertainment, cable television, and online companies, as well as related retail businesses.
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