movieconomics: should movie theaters change their pricing system?

Have you ever wondered how movie theaters make money? Sure, they make it off ticket sales, but how do they split the profits with the movie studio? And why do all movie tickets cost the same, regardless of the quality of the movie or the time of the year? These questions led me to do some research and make a blog post on movie theater economics. My findings were more complicated than expected, but I have tried to simplify the facts by writing a paragraph or two about many of the possible questions one could have about how movie theaters make money and what they could do to make even more.

how do theaters and studios split profits?

This question is more complicated than it seems, since the method of splitting profits depends on the movie and theater. In At the Movies: The Economics of Exhibition Contracts, Filson, Switzer, and Besocke write (emphasis added):

While some contracts are “aggregate” deals, in which each side’s percentage share remains fixed throughout the run, most are ‘sliding scale’ deals. In a sliding scale deal, each week, the distributor gets the maximum of two possible payments: 1) 90% of the movie’s weekly ticket revenue over the ‘house nut,’ which is a flat payment to the exhibitor; 2) a ‘floor payment,’ some percentage of the weekly ticket revenue that typically declines according to a ‘sliding scale’ as the weeks go by – perhaps 70% in the first week, 60% by the third week, and as low as 30% at the end of the run. If the parties anticipate that revenue might peak in the second or later weeks (which can occur when the movie opens before a holiday weekend, for example) the contract includes a ‘best weeks’ clause that ensures that the high floor payments are associated with the high demand weeks.

The difference in profit splitting between different theaters and movies is demonstrated by a study of a theater chain in St. Louis, Missouri from the same article:

The sharing rules vary substantially by movie and theater. For example, in sliding scale deals the exhibitor’s share ranges from 23-70% in week 1, 30-70% in week 4, and 40-70% in week 8. Run lengths depend on performance and vary from 1 to 28 weeks in our data; the average run length is 5 weeks.

According to Forbes, theaters on average keep 45-55% of ticket sales throughout an entire theatrical run.

are concession profits split?

No, the theater takes all of it. Theaters make lots of money at concession stands; around half of their profits. According to Time, around 85 cents of every dollar spent at concession stands is profit for the theater. People often complain about the ridiculous price of items like soft drinks, but high concession prices keep ticket prices lower. The Stanford Graduate School of Business article “Why Does Movie Popcorn Cost So Much?” (the full article is actually worth reading if you’re interested in learning more on the subject) explains (emphasis added):

By charging high prices on concessions, exhibition houses are able to keep ticket prices lower, which allows more people to enjoy the silver-screen experience. The findings empirically answer the age-old question of whether it’s better to charge more for a primary product (in this case, the movie ticket) or a secondary product (the popcorn). Putting the premium on the ‘frill’ items, it turns out, indeed opens up the possibility for price-sensitive people to see films. That means more customers coming to theaters in general, and a nice profit from those who are willing to fork it over for the Gummy Bears.

why don’t theaters just lower ticket prices so they can sell more concessions?

Since theaters get all the money from concessions, but have to share profits from ticket sales, they have an incentive to lower ticket prices so more people will go to the theater and buy concessions. The previously mentioned article At the Movies: The Economics of Exhibition Contracts, discusses this issue:

The exhibitor gains from adjusting p only if the adjustment occurs after the contract is signed. If the exhibitor adjusts p before the contract is signed then the distributor will simply argue to change the sharing rule to ensure that the exhibitor still gets its reservation utility. Given that exhibitors include their proposed p in their initial bid, a subsequent adjustment would violate an implicit contract. Such behavior could cause the distributor (and perhaps others as well) to punish the exhibitor in the future. This encourages exhibitors to keep p up (15).

The letter p represents the price of the ticket.

why do tickets cost the same for all movies?

There is good reason to believe that theaters are making a mistake by charging equal prices for all movies. There is a detailed 22-page article on this subject called “Uniform Prices for Differentiated Goods: The Case for the Movie-Theater Industry,” which was published in the International Review of Law and Economics. I have provided a brief summary of the responses of the article’s authors, Orbach and Einav, to five main perceived problems with nonuniform ticket pricing.

1. Consumers would perceive theaters as being unfair if prices were not uniform.

This isn’t necessarily true. First, theaters started using uniform pricing in the early 70s, so because people used to deal with nonuniform pricing, it is not unrealistic to think that they would be willing to accept it again. Secondly, not all movies are the same and charging different prices for different products is not really unfair. Orbach and Einav explain (emphasis added):

Despite the difficulties that fairness perceptions may present, they cannot justify uniform admission prices. Uniform prices seem fair because of the system’s regularity, not because of any intrinsic justice. No sophisticated schemes and ploys are needed to change the present reference transaction; in fact, simple marketing mechanisms could do the trick. The starting point is the distinction between the movie and the show-time puzzles. All consumers are familiar with the concept of different prices for different products, although for some consumers charging different prices for products they consume at different points of time may appear unfair at first. Thus, charging premiums or giving discounts for unique categories of movies is unlikely to be perceived as unfair. For example, given the unique characteristics and highly publicized production budgets of event movies, charging premiums for such movies probably would not violate fairness perceptions. Indeed, past experience and international markets provide good reasons to believe that patrons would not perceive such a practice as unfair. It also seems unlikely that discounts for films whose demand is relatively elastic, such as documentaries, would be perceived as unfair (145-46).

2. Consumers would be less likely to go to movies with lower prices because they would believe that they are worse movies.

The Avengers is an example of an event movie.

Orbach and Einav believe that this argument is only valid for movies that are similar. If a theater charged more for an “event” movie, which is a movie whose arrival is a big deal and often has a huge budget or is a sequel to a popular film, consumers would probably not believe this action signifies that the other films are worse. Also, if prices were lowered on different types of movies, such as documentaries, demand may actually increase, and consumers would be able to tell that the lowered price does not mean the movie isn’t good (146).

3. Theaters would not be able to know which movies should be priced higher.

This film was so unpopular that the Lone Ranger probably wasn’t the only lone person at many showings.

Frankly, this just seems like a dumb argument. Sure, sometimes movies perform a lot worse than expected, like the Lone Ranger, but in general I’m pretty sure companies can tell that the sequel to The Avengers is going to make a lot more than, say, Ant-Man, which is an actual superhero film scheduled for a 2015 release. In fact, there is an entire website dedicated to predicting how well films will perform at the box office called the Hollywood Stock Exchange. HSX, which may be the subject of a future blog post, is a virtual stock exchange where players buy and sell fake stocks of movies and actors. Orbach and Einav’s response to the demand uncertainty criticism is as follows (emphasis added):

…empirical evidence shows that demand uncertainty is not as great as popularly argued and that the determinants of success in the industry are not totally random (see Section 2.2.1 and Moul, 2004). Producers may be unable to predict the demand for specific movies, but can identify with some level of confidence certain categories of movies with unique demand characteristics, such as event movies and documentaries. In fact, studios make significant investments in studying consumers’ preferences to improve their ability to forecast box-office revenues (Bakker, 2003). Empirical evidence suggests that production budgets, sequels, participation of stars and top directors, ratings, competition from other movies, and advertising are all significantly related to revenues and thus can be incorporated into pricing decisions  (147).

4. Nonuniform pricing could result in people taking advantage of the system by sneaking into higher priced movies.

The Atlantic article “Why Do All Movie Tickets Cost The Same” explains, “[Nonuniform pricing] would create a fascinating incentive for art-house studios to release smaller, cheaper films the same weekend as blockbusters, knowing that thousands of canny consumers might buy fake tickets to their show to sneak into the more expensive blockbuster.” However, Orbach and Einav essentially debunk the claim that this problem is serious enough to justify uniform pricing (emphasis added):

In practice, exhibitors already employ mechanisms that could mitigate much of the arbitrage opportunities. Today, some screens are sold out while others are not, and, therefore, exhibitors must monitor the patrons entering sold-out movies. Otherwise, patrons who could not purchase a ticket to a sold-out movie could use a ticket to another movie. Similarly, exhibitors must prevent moviegoers who buy matinee tickets from watching evening shows and, at the multiplex, they must prevent moviegoers from watching two movies in a row for the price of one movie. One indication of the possibility to administer variable pricing with reasonable monitoring costs is the prevalence of price discrimination across seats in some countries (Cheung, 1977) and at some theaters in the United States, as well as the prevalence of reserved seating in many international markets. Put simply, the arbitrage opportunities under a variable-pricing regime are similar to those that already exist today and, therefore, cannot explain a firm uniform pricing regime (148).

5. Theaters could take advantage of nonuniform pricing and the studios would make less money.

I’ve already addressed the idea that theaters could just lower prices and make more money because more concessions would be bought. Another concern involving theaters taking advantage of varying prices is the fact that they could report that sales for higher-priced movies were actually for lower-priced movies and take the difference for themselves. As Orbach and Einav point out, though, this complaint makes little sense, since theaters could already report more sales for movies which they get a higher percentage of the price from. In addition, they could just under report how many people bought tickets and keep more money (148). The previously mentioned Atlantic article makes a couple of additional criticisms. The first is that theaters already  favor certain movies by giving them more and larger screens. I honestly don’t understand why that is an argument against  varied prices. Secondly, the article says that another reason to not adopt nonuniform pricing is that if one theater raises prices for certain moves, and another doesn’t, some people would go to the lower-priced theater even if they live closer to the one with higher prices. This concern seems legitimate, but it only applies to people who are willing to travel a potentially much longer distance to save what is probably not much money. Therefore, I doubt it is a sufficient reason to use uniform pricing. Also, if all theaters raised the price of a certain movie by the same amount, there would be no stealing of customers.

why do tickets cost the same throughout the year?

Although matinees cost less, movies are otherwise priced the same year-round. However, if demand is greater on certain days or seasons than on others, it makes sense for theaters to raise ticket prices.

Photo from The Atlantic.

On the subject of varied prices based on the time of year or day of the week, Orbach and Einav write (emphasis added):

Much of the reluctance to adopt variable pricing stems from formidable concerns about the costs of administering and policing price differentiation across movies. Such differentiation may present a challenge to the industry, but it should neither be confused with, nor should it supersede, price differentiation across show times. Practical obstacles to variable pricing across movies, if such exist, cannot explain why movies are priced uniformly on weekdays and weekends and throughout the year. Thus, those who remain skeptic of the viability of price differentiation across movies, should still accept the view regarding the likely profitability and viability of non-uniform prices along the show-time dimension (150).

Another idea for how to vary ticket prices is by reducing the price every week or so. A criticism of this idea raised in the Atlantic is that “[y]ou can’t consistently cut prices after a successful opening weekend. If people knew that ticket prices would fall after a big opening, many more would wait until the second or third weekend to see it, which would, ironically, destroy the meaning of opening weekends.” I think this claim is mostly true, but it may not be the case for event movies. I remember a few years ago my math teacher was talking about if movie prices should be nonuniform and asked the class how many of us would be willing to pay $25 to see the latest Harry Potter film on opening day. Around a quarter of the class raised their hands. Therefore, theaters could potentially raise prices to very high amounts early on for event movies, and later the price could become the same as other movies. This way everyone who doesn’t want to pay extra would pay the same price as they would if all prices were equal, and the theater would make more money.

will we continue to see uniform ticket prices in the future?

We may not. According to ABC News, Steven Spielberg recently said, “You’re going to have to pay $25 to see the next ‘Ironman.’  And you’re probably only going to have to pay $7 to see ‘Lincoln,'” suggesting future high-budget films will cost more to see than lower-budget ones.

have movie tickets become more expensive over the years?

Photo from The New York Times.

Yes and no. As the graph to the side from a New York Times article shows, movie prices have indeed increased in recent years. However, the article also states that “Patrick Corcoran, the director of media and research for the National Association of Theatre Owners, points out that a ticket purchased for the average price of $1.65 in 1971 would cost $9.20 today — higher than the actual industry average, if adjusted according to the general inflation rate.”