Digital cinema slow to reel in fans

With the May release of George Lucas' "Star Wars: Attack of the Clones," the spotlight is focused on the promise of digital cinema. But 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 can find creative ways to finance the multibillion-dollar cost of the changeover.

It seems like the people with the most enthusiasm for digital cinema technology are those making movies with it. A half-dozen of the 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. The most prominent was "Clones," whose director seemed as intent on spreading the word about digital cinema as he was on hyping his movie. Still, although "Clones" was shot digitally from beginning to end, few moviegoers actually saw Lucas' film in its digital form. When it opened in the United States, 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 are not. Their argument: With 36,000 screens in the United States, it could cost $5 billion to $7 billion to upgrade the entire infrastructure.

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 in to 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 United States, 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.

It seems like the people with the most enthusiasm for digital cinema technology are those making movies with it.

There are benefits for theaters, 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.

Still, all of the potential economic advantages of digital cinema 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.

For the studios, there are other obstacles to digital. For one thing, it's not clear 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. The studios are also fearful that distributing their films over computer networks will lead to piracy.

Meanwhile, the revenue-sharing arrangement between theater owners and studios 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.

The promise of additional revenue from advertising or other uses of the facilities 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. 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.

For this industry, spending money without a quick payback is not part of the culture.

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 capital into the system.

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.

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Reprinted with permission from strategy+business, a quarterly management magazine published by Booz Allen Hamilton.