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Digital Cinema: Promising Future, Dicey Debut

Will digital cinema ever come to a theater near you? Filmmakers are talking up the technology, but studios, theater owners, and distributors still need to work out the financial hurdles.

(originally published by Booz & Company)

With the May 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 full acceptance of digital by the film industry may remain a distant possibility, unless key players can redefine how they share revenues and find creative ways to finance the multi-billion dollar cost of the changeover.

“A half-dozen films shown at this year’s Cannes Film Festival were shot at least partially using digital, which stores video and audio as digital data so that it can be manipulated and transmitted electronically.”
It seems like the people with the most visible enthusiasm for digital cinema technology are those making movies with it. A half-dozen of the films shown at this year’s 11-day Cannes Film Festival were shot at least partially using this new technology, which stores video and audio as digital data so that it can be manipulated and transmitted electronically. The most prominent was Clones, whose influential director seemed as intent on spreading the word about digital cinema — the high quality of its picture and sound, the ability to more easily create dazzling special effects, the lower cost of filmmaking — as he was on hyping his movie. Still, although Clones was shot digitally from beginning to end, few moviegoers actually saw Mr. Lucas’s film in its pure digital form. When it opened in the U.S., only 60 screens out of 5,000 displayed it using digital projectors.

Good News, Bad News
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 — are not. 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 effectively gets films produced, distributed, and exhibited to audiences around the world? Furthermore, conventional projection equipment is almost legendary in its reliability and longevity. Plus, in contrast to digital music, there isn’t a customer base clamoring for digital cinema.

Proponents counter that this attitude, tied to an aging business model and old economic assumptions, ignores the promise of digital cinema not only as an entertainment medium, but also as a way to drive down costs significantly 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 ultimately destroy the film reels produced. With digital cinema, much of this cost to the studio would be eliminated because movies can be created, stored, distributed, and projected electronically.

“A new Booz Allen study says the film industry’s support of digital cinema will remain weak unless key players can redefine revenue sharing models and find ways to finance the multi-billion dollar cost of changing the current system.”
For theaters, there are benefits, too. Instead of being constrained by the number of prints they have, theaters can instantly access a digital movie with any projector linked to their server, and simultaneously increase the number of screens showing it. Consequently, theaters would be filled closer to capacity more often, increasing revenue opportunities.

Digital cinema also paves the way for theater owners to show new types of content, including preshow advertising and special presentations of live events, such as sports or concerts, which appear to be under-exploited today due to 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.

Practical Hurdles
Still, all of the potential economic advantages of digital cinema — close to $1 billion in additional annual revenue for theaters, and $1 billion in cost savings for studios — pale in comparison to the estimated $5 billion to $7 billion to upgrade the infrastructure, and can’t justify a complete switchover in a short period of time. For this industry, spending money without a quick payback is not part of the culture.

Moreover, for the studios, there are other obstacles to digital. For one thing, it’s not clear yet which of the competing technological specifications will become the standard for digital cinema, and until that is determined, studios will be reluctant to risk backing the wrong approach. In addition, the thought of operating two different distribution systems for a period of time is not particularly palatable. And, most serious of all, the studios are fearful that distributing their films over computer networks will lead to piracy.

Meanwhile, the revenue-sharing arrangement between theater owners and studios — an outdated 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 movie’s 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.

“Distributors could invest in 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 movies.”
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 are scraping for cash. Starting in the mid-'90s, theater chains spent billions to build megaplexes, luring moviegoers with stadium seating, larger screens, and expanded concession areas. But the interest payments for the construction boom combined with lease commitments on older, unused theaters drained profits. By 2001, a dozen major chains filed for bankruptcy. With this economic backdrop, there isn’t a lot of cash available for capital investments involving long-term returns.

What Distributors Could Do
So with the studios and theater chains resistant to digital production and distribution, the only hope for digital cinema may lie with the film distributors. These companies collect upward of $1 billion in fees a 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, they’re slowly beginning to infuse the first round of much needed 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 the 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 movies. In addition, distributors could syndicate advertising and alternative content, given their relationships with the full universe of theaters.

Digital cinema is an exciting technology that promises to transform the neighborhood theater into a more versatile and profitable entertainment space. But the capital investment requirements and the conflicting interests of industry stakeholders have slowed progress. For now, the distributors have emerged as the most likely candidates to break the logjam.

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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