May 2013
Volume 33 No. 3

May 2013
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Residuals Are as Easy to Explain as Difficult to Calculate

Residuals have long been a source of contention be-tween the writers’, actors’ and directors’ guilds (unions) and the producers/studios that own (and exploit) TV and film content. And virtually every strike against the Hollywood studios in the last 50-plus years has been about residuals — initially about establishing residuals at all and, since 1960, about trying to fit new technologies into an existing residual system.

During the 2007-2008 writers strike, for example, the major sticking point was how writers would be compensated for re-airing of content across the Internet and mobile devices, in other words: digital residuals. While experts say the system works for now, changes are likely in store.

For the most part, digital residuals for all non-library (new) product represent a percentage of gross. Those percentages vary based on what platform the content was originally made for (e.g. theatrical release, free-TV, pay-TV, etc.) and the digital platform where it’s ended up (e.g., consumer-paid new media or ad-supported new media).

Residuals are calculated “at source,” meaning that, for example, residuals on DVD revenue are calculated based on the amount retail stores pay to the owner of the content (usually a studio), not based on the (higher) amount the consumer pays. In the case of Electronic Sell Through in new media (e.g., iTunes downloads), the percentage is based on just 20 percent of gross at retail. The same is true for DVD retail.

New media is generally divided into two types — ad-supported (e.g., Hulu) and consumer paid (e.g., Netflix). Consumer-paid is divided into eRental and Electronic Sell Through. For the most part, the percentages for subscription-based services like Netflix services mirror pay-TV. But that doesn’t mean writers, directors and actors can expect similar pay-outs. Since the gross received by the content owner is significantly lower for new media, the amount of money paid out to those in the guilds is too.

In ad-supported re-use of TV product, there is always a period of time where content can be exploited and residuals don’t have to be paid — that’s a period of 24 days in the case of a TV series in its first season or a movie for television. If a series is in its second season, there’s a 17-day residual-free period.

The ad-supported Hulu-style is “one of the most complicated of all, because there can be differences based on budget, and whether something is in the first season or not,” said Jonathan Handel, an entertainment attorney with Los Angeles-based TroyGould. And despite the fact that the service is ad-supported, the percentage of gross is based on a license fee, not on advertiser dollars.

“Nothing is straightforward about any residual calculations. If something is made for broadcast television and reused on an ad-supported Internet platform like Hulu, the formula is completely different than something that is released theatrically and then goes on to a consumer-paid platform [e.g., Netflix],” he said.

Schuyler Moore, a Los Angeles partner in the corporate entertainment department at New York City-based law firm Stroock & Stroock & Lavan, said, “It’s a very big issue. It’s a hot issue.”
Moore suspects that an increasing number of digital distribution platforms will hurt the studios, as they have to pay out more and more residuals. “At some point they’ll need to put their foots down. The percentage of the gross in a world of such thin margins, is not workable,” he said.

One executive in the residuals department of a major studio said that post-strike, digital residuals have been pretty clear-cut, but agreed that changes are likely in store as technology advances.

“The digital distribution of our content is changing very fast,” said the executive, who wished to remain anonymous. “The provisions that were put in place in 2008 [after the writers strike] cover the changing landscape, but the way distribution is changing, more provisions may apply.”

In an article about SAG negotiations published in The Hollywood Reporter in 2008, Stroock attorney Moore accurately predicted that VoD residuals would turn out to be more important than DVD residuals (as VoD would replace DVD in popularity). Given his ability to predict the future once, we asked Moore to look into his crystal ball again.

“I am fundamentally a believer that this content will go free and ad-supported,” he said. “We’re going to see gradual migration to everything becoming free past the primary market. There will be a unified day and date release — across theatrical, video, VoD, etc. and then it’ll be free and ad-supported after that.” That will complicate things in the residual space even more, said Moore, since as of now, residuals are based on a fixed license fee rather than ad revenues.

Another issue experts expect to shake things up is an area called original new media — original programming created for digital platforms, like Netflix’s House of Cards or Hemlock Grove. The problems are multifold: First there’s the fact that new, original series may replace the need for companies like Netflix and Amazon Prime to buy content from the studios.

In fact, last month Netflix announced plans to license shows selectively from producers, rather than relying on broad, multi-year deals with networks and cable channels. And in a recent report, media analyst Michael Nathanson of London-based Nomura Equity Research warned that companies such as Viacom and CBS will see bottom lines harmed as they lose high-margin license fees from companies like Netflix. As a result, residuals can only be expected to be smaller, too.

Then there’s the fact that the residual model for a show like House of Cards may have to be unique and created from scratch.

“It’s becoming a given that, to peel people away from cable, and to differentiate themselves from their competitors, companies like Amazon Prime and Netflix have to invest in original series,” said Handel. “It’ll be interesting to see how those issues will enter into the guild contracts.” (By Lucy Cohen Blatter)