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MONEY is only a profit when your revenues are more than costs and expenses and when your cash inflow is greater than cash outflow over a particular period of time. Whilst that sounds like a mad accountant, it is a necessary madness if you are to run a business in the Creative Industry. Datuk Zang Toi once quoted, “In the fashion business, creativity only accounts for 10% of the effort; and the remaining 90% are all business acumen”. This is from an international creative practitioner and it is not merely an academic statement. It is a proven concept as evident in Zang Toi’s success stories.
One of the more controversial money issues is the royalties for creative content. This debate has been going on for decades particularly involving TV broadcasters and production houses. The basic concept to comprehend this issue is the understanding of equity stake mechanism for Intellectual Properties (‘IP’) and the relationship between risks and rewards. The party who puts in the investment should be the party that reaps the benefit. If any party to a deal wishes to reap the benefits of a particular IP, then that party should put their skin in the game, i.e. invest fully or partially. Let us use TV production as an example. Typically, a TV production can happen under two models: Commissioning or Licensing. The former is fully invested by the broadcaster and the latter by the production house.
Under the Commissioning approach, a broadcaster puts in all the financial resources to a TV series and commissions a production house to produce it. The broadcaster owns the IP and any future economic benefits that can be derived subsequently goes to the broadcaster. On the flipside, a production house may put in all the financial resources to produce a particular TV series and upon completion (or partial completion), sells the right for broadcasting to broadcasters under licensing deals. Licensing deals normally have a limit to which extent a broadcaster is allowed to air the content on TV – either on a limited number of runs basis or within a particular licensing period (e.g. 2 years); or even both together. The production house must make this calculation and assess their business position. Are they in the position to earn lower licensing income and endure a longer runway to earn future income? Or, do they want to get all the money up front and not wait for any more in the future? Or, on a more balanced approach, share both revenues and costs with broadcasters.
Under the Commissioning method, the Malaysian broadcasters pay between RM45,000 to RM80,000 per episode depending on the treatment, crew, casting and storyline. So, a 20 episode series can earn revenues of RM900,000 to RM1.6 million for the hired production house but it stops there. Under the Licensing method, the production house incurs the production costs but each episode can only earn less than RM5,000 licensing income from the broadcasters. However, the production houses who are also the ownersof the IP, can get multiple licensing deals with multiple broadcasters and on-line streaming platforms. A sharing model cuts everything in the middle assuming a 50:50 sharing basis. In such cases, instead of the production houses incurring nil costs, the production houses incur RM22,500 to RM40,000 taking 50% of the broadcasters’ burden. Then, whatever revenue that can be derived is split 50:50 between the broadcasters and the production houses. This means, the production houses now bear the same risks as the broadcasters, i.e. the risk of inadequate revenues to recover the production costs.
Production houses need to be aware of all possible revenue windows if they are to invest in the production of creative content for which they retain the ownership of the IP for that particular content. What are the typical windows? For films, normally the first window would be the cinemas. When that is exhausted, they may choose to sell to Pay-TV operators such as Astro First or sell to Free-to-Air (‘FTA’) TV stations such as TV3, or both, one after the other. The fourth window can be the on-line video streaming platforms such as Netflix, Iflix, Viu, Dim Sum and many more. A decade ago, selling DVDs used to be a lucrative window. Today, that revenue stream can be considered extinct.
Whatever the windows may be, if the deal with the buyers involve prolonged exclusivity period, it can cause issues in the industry. Extreme exclusivity terms can cause a downward spiralling of the economic well being of the creative industry. It practically kills the production houses’ ability to maximise revenues. Exclusivity that goes to the extent of two years is not good. A better time frame would be six months. Of course, the price should be adjusted accordingly. Under the Astro First model, they used to be priced at a few hundreds of thousand Ringgits. However, with the expansion of various on-line streaming services (also known as Over-the-Top (‘OTT’)), the pricing benchmark has been disrupted and to date, no standard pricing has been established yet.
What we can see is that, for the very first time in Malaysia, a local movie has been bought by Netflix, i.e. Pulang by Primeworks Studios in 2018. That deal opened the doors for more local movies to be on Netflix, namely Munafik 2, Hantu Kak Limah, Paskal and Crossroads One Two Jaga. The previous trend of local movies’ box office collection used to be quite gloomy. Although the cinema collections grew yearly, it is mostly fuelled by Hollywood titles. However, movies such as Khurafat and The Journey, that had collected RM10 million and RM17 million respectively, started a new encouraging local movie box office trend. In 2018, Munafik 2 reached RM47 million, Hantu Kak Limah at RM36 million and Paskal around RM20 million.
The windows of revenue would normally end with a small but recurring long tail of cash flow streams if the IP is successful. One good example would be old movies that kept on reappearing on TV even decades after its initial release. To name a few, Bukit Kepong and Matinya Seorang Patriot have managed to reappear even after the turn of the millennium. P. Ramlee movies would probably hold the record for Malaysian films that have the longest tail of cash inflow streams over so many decades and continue to do so today –Pendekar Bujang Lapok being the most popular one. An IP’s potential does not just stop at the content format. Some extended to earn other forms of licensing such as merchandising. This is evident in the case of Upin dan Ipin for which, its Stock Keeping Units (‘SKU’) spans across apparels, stationeries and even restaurants. In fact, the measure of success may even go beyond the local boundaries into other geographical regions.
As mentioned earlier, revenues need optimal costs to tango with before any profits can be derived at. Various aspects of production costs need to be managed up front in order for a viable decision making to be made. Questions such as which director to hire? Who would do the scriptwriting? profile of the casting; crew members selection; and many more. Typically, whilst the amount of time spent during pre-production is quite long, the costs incurred shouldn’t be too high. Pre-production activities that cost 10% of the entire production budget sounds fair. Meanwhile, 50% of the budget should go to the actual production and the remaining 40% on post-production activities that include colour grading, voice overs, music, sound effects, editing and of course, Computer Graphic Images (‘CGI’), if need be. In the case of an animation, one would probably push more percentages for CGI.
Costs do not stop at pre-production, production and post-production only. One important element that must not be forgotten is Advertising and Promotion (A and P). Many producers make the basic mistake of not spending fairly on A and P. What is the point of having a superior product or services when the intended consumers are not aware of it. Benchmarked against various projects, a fair quantum of A and P would probably be at a minimum of 30% of the entire Production budget. So, add up pre-production , production as well as post-production budgets and times that by 30%. That is your optimal marketing strength. There have been numerous examples of good content not achieving financial targets simply because of the reluctance on the producers’ side to incur marketing expenses –movies, theatre shows or even concerts are known to be loss making and most of the time it is because people (consumers) do not know its (creative products) existence.
Foreign players have shown really good examples of how marketing can really boost their sales. Netflix is known to have rented huge outdoor billboards at strategic traffic locations so that they catch the eye balls that are intended for their programmes. Netflix is naturally targeting the urban consumers. As such, they have chosen locations such as the Sprint Highway or Lebuhraya Damansara Puchong (‘LDP’). Whilst digital advertising is the first choice of medium for urban advertising, nothing beats the traditional and hard core ‘In Your Face’ billboards.
Maximising revenues and optimising costs achieve profitability but it does not necessarily put us in a positive cash flow position at the right time. The timing of revenue recognition is never the same as cash inflows. Likewise, the timing of costs incurrence is never the same as cash outflows. Cash collection from cinemas or even TV broadcasters can be late. In the case of cinemas, the box office collection normally requires weeks before a complete calculation is done to confirm the final numbers. When this happens, production houses will find themselves stuck in a situation where payments are due but cash is not yet in. Producers often pays their crew members, directors and casting upfront. This causes cash shortages and disrupts all other production within the company’s slate of projects in a particular time frame. More care must be taken when that slate of production involves multiple productions that happen at the same time or significantly overlapping for a good portion of the production runs for the multiple projects.
How do you then address that cash shortfall? For those with adequate cash, they will use their own money. Others may take loans from various Financial Institutions (‘FI’) although many FI’s are somewhat allergic to creative businesses. Some would give (loans) but charges expensive interest rates as high as 12%. The financial facilities obtained from the FI’s need to be standby facilities whereby production houses should only draw the loans when production has been confirmed and locked in. Having discussed the timing of cash inflow, we must not forget that the funding from the loans are meant to pay for the on-going production costs. When the actual revenue collection comes in, that cash must strictly be channelled back to the FI’s with the view of repaying back the loans drawn inclusive of the interest expenses that have been accrued on the loan amounts from the day it was drawn.
Many producers forget that they also need to pay fixed overheads. Not that they forget that they need to pay those costs but they forget to acknowledge that the profit margins from the various projects need to be enough to cover fixed expenses that recur on monthly basis. These are items that you will need to pay regardless of whether you have any projects in hand. Examples would be rental expenses, utilities, salaries of permanent staff, maintenance of equipment and of course, any interest expenses incurred as a result of loans taken to finance the company as a whole. The sum of all this is what investors normally refer to as the ‘Burn Rate’. When a potential investor asks, “What is your Burn Rate?”, it means that they want to gauge how much would you need as a basic before you can comfortably embark on the project itself. A healthy business should already have enough cash balance in the bank to fund its Burn Rate for a minimum period of 3 months. In fact, many investors prefer a longer period such as 6 months to a year.
In 2013, a well known American animation company, Rhythm and Hues, hired many Malaysians as their core workforce. They were big and highly skilled. However, given their Chapter 11 status (American bankruptcy regulatory status), the company had to be shut down leaving hundreds of staff unemployed. Had Rhythm and Hues preserve sufficient cash for their Burn Rate, a White Knight might have been able to complete its due diligence in time to inject funds for the continuation of the projects in hand. It was a ‘Chicken and Egg’ situation. The staff wouldn’t stay unless they were comforted with salary payment and the investors wouldn’t come in if they were not comforted with project delivery commitment. This demonstrates the importance of cash flow management. A company that records a huge profitability can still go bust when cash flow management is down the drain. The basic understanding to remember is that the timing of cash inflows must be adequate to cover committed cash outflows at the minimum rate of allowing continuous operations –a ‘Going Concern’ assumption.
The critical need to ensure cash flow viability warrants effective negotiating skills. Prices and timing of collection need to be negotiated with buyers. If the timing is prolonged, it is effectively suggesting that you (producers) are bearing the costs of financing on behalf of the buyers. This is because the ideal situation would be otherwise, i.e. Buyers drawdown loans with interest expense in order to pay producers. Hence producers would not have to take up loans to pay their suppliers. A healthy cash inflow level can be determined by ensuring adequate quantum, inclusive of some buffer, to cover production costs. Likewise the management of production costs, both incurrence as well as payment timing, will also need to consider the conditions of cash inflows. The difference between revenues and costs is the gross margin. Gross margin needs to be enough to cover the Burn Rate (or also known as overheads). However, this is only possible if that is reflected in the excess of cash inflows versus cash outflows.
At the end of the day, the company must make a profit. All revenues less all production costs and overheads as well as interest on loans should leave behind residual as Net Profit that is worthwhile. If not, all the efforts will be put to waste. The question is, “What is a worthwhile Net Profit?” A good measure for this is by comparing to other forms of profits. Had you invest the same amount of money (i.e. the sum of production costs, overheads and interest income) elsewhere, you would have earned a certain income such as dividends of 7% from unit trusts, or 3% interest income from a fixed deposit bank account. In fact, given the efforts being put into creative production projects, that 7% benchmark would probably need to be added with a premium making it reach 10% or higher. Generally, as a rule of thumb, any business needs to achieve a minimum Net Profit margin of 10% to 15%. Otherwise, you might as well close the business and put the money into money market instrument that earn passive income without having to put in a lot of effort, or any effort.
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