Friday, July 24, 2009

Fixing the Residuals System

The residuals system is broken. It’s expensive to administer and is an invitation to conflict as platforms such as new media evolve. Yet we need residuals, because talent survives on these payments between gigs. Can the system be fixed?

Yes, I believe so. For a proposal, see my piece in today’s Hollywood Reporter.


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  1. J,

    I am afraid your idea is simply suggesting that everyone agree to use a modern buggywhip, even though there isn't a horse in sight. Automating the system will make it a more efficient buggywhip, but if there are no residuals to speak of, there's nothing to be efficient about.

    Residuals worked well when the business worked on the basis of controlling access to content. If you controlled access, you could steer your audience to a time and place to view your content and charge them for it. That doesn't work any more. To succeed, your idea needs the consumer to agree to get their content only from those "approved" sources that generate the revenue to pay residuals and other creators.

    How's that working out for the music industry?

    It is time to start thinking beyond residuals as a way to compensate everyone involved in the creation and exhibition of content.

  2. Nice article, simple idea.

    So why hasn't it always worked like this? Whence the current complexity? Who benefits?

  3. Fred:

    Actually, the music industry hasn't died out any more than VHS killed the movie industry.

    People still buy music -- RIAA propaganda aside. They'd probably be buying a lot more music if RIAA hadn't dragged their feet in entering the internet era and had actually SOLD content in the format people wanted. Instead, they set the stage for piracy...and now we all pay the price.

    You have a point, though. Residuals depend on the distribution economic pipe being connected to the residual pipe. But you don't offer an alternative. If there are no sales of content, where is the money for paying people going to come from?

    I can't see the money appearing, if there's not downstream revenue. Nobody is going to put in up money up front without an expectation of making it back -- through sales, rentals, performance, theaters, advertising -- any other ideas to add to the list?

    I can't think of a single viable way for content to earn its keep up front. Given that all the earnings are downstream, residuals would still seem to make sense to me -- no matter HOW many problems the industry may have with those downstream revenues.

  4. Bob,

    There's more music being made as there was before, and probably just as much money being made on music, but it isn't being made in the same way, and it largely isn't being made by the same people, and therein lies the cautionary tale for creators of visual content.

    The recorded music business was built on sales of physical product. When on-demand consuming no longer required possession of the physical product, that business model no longer made sense. It is why the major labels are so insistent right now on getting a performance royalty from terrestrial radio. If they get paid every time a station plays one of their records, they don't need anyone to buy a single copy.

    It is the major labels that succeeded in an environment where distribution was controlled, and it is the major labels who have suffered the most now that distribution cannot be controlled.

    And that may well suggest the alternative you chide me for not mentioning; a blanket license, collected by every ISP from every customer, that permits every customer of that ISP to not only watch whatever content they want, ad-free, but, heaven forbid, download it too. Some centralized entity collects the money, figures out how it should be divvied up and sends out the checks. Performers trade their consent to the new exhibition system for a share of the revenue as compensation. They could even be paid directly from the collection agency, removing the possibility that the producers can pull some accounting tricks.

    Divorce the idea of compensation from the idea that distribution can be controlled. Once your content is in the marketplace, it is already in the ocean of content out there. There is NO downstream, because there is no stream.

    So, what do you do?

    Attach the idea of compensation to the idea that everything is accessible, all the time, which it pretty much is anyway. Get paid from a pool of money created by the ISPs to compensate creators. The ISPs are just going to pass the charge onto the customers, where it belongs anyway.

    It's the principle behind the way the RIAA set up SoundExchange to deal with performance royalties from Internet radio. SoundExchange has been a disaster for performers (they've found and paid fewer than half the artists who they have identified, and they've accumulated over $100 million in undistributed artist performance royalties in six years), but that's a failure of execution rather than concept. There's no reason the concept couldn't be applied to visual content.

    Residuals are based on a model in which distribution is controlled. No one controls Internet distribution, at least not for long, so residuals just don't make long term sense as a compensation model.

    You have to move the basis for compensation to providing open and on-demand access. A blanket license, in the form of a monthly per-capita fee collected from the ISP is the simplest way to achieve that.

  5. Jonathan,

    I'm usually 100% on the same page as you but I have to say, this article is really off the mark. I think the basic concept you're working from (aggregate all revenue and define residuals on that stream) is absolutely correct but you make two glaring errors. The first:

    "In any case, the proposal violates the guilds' requirement that members participate in the success of a project, which generally means via gross -based residuals."

    This statement is a paradox. If guilds have a requirement that the membership participate in the success of a project (reasonable) then that should mean the NET, not the gross. Pluto Nash had gross revenue but no success. If the theory is participation in success then there should be no residuals there.

    The second error is the idea that residuals should be an absolute number, irrespective of performance of the industry, and should increase year after year (much like the system for generating the federal budget). But what if you have a massive decline in revenue one year? Why should the percentage paid in residuals swing massively higher (the revenue would decrease but absolute residuals would increase at the proscribed rate)? That's profoundly illogical.

    I think a much better proposal is to say 5% of gross revenue from all revenue streams is set aside for residuals - 1% for writers, 1% for directors, 3% for actors divided pro-rata based on up front compensation on a given project. However you are allowed a credit for the up-front costs. Therefore if you pay $100,000 to a writer, $100,000 to a director and $300,000 to cast then the first $10M in gross revenue is recouping the up front and 5% of every dollar after that gets split. In this model, if the film cost $10M then everyone starts to make money at that point. If the film cost less than $10M then the producer has made a bit of a profit and it is slightly more favorable to him or her. If the film cost more than $10M the producer has at least had a reasonable opportunity to recover the risk capital of the creatives and he or she is in the red a little longer.

    It's fair to everyone. Creatives participate in genuine success and in ALL revenues evenly. Producers get a reasonable opportunity to recoup their capital at risk. Everybody lives happily ever after.

  6. Hi Noah -

    Thanks for the compliment and your comment.

    Re your first point: it's fine to say that participating in success "should" mean net, but that's not how the guilds see it. If you don't accommodate their view, as well as the studios' view, then there's no deal.

    Re your second point, how did you arrive at 5%? If your 5% calculation yields a total residual load for 2010 (for instance) that's bigger than what it would be under the current system, then the studios won't accept it. If it yields a smaller number, then the guilds won't accept it.

    And, if your distribution amongst the guilds (1% writers, 1% directors, 3% actors) yields a different sharing among the guilds than at present, then the disfavored guilds won't accept it. (The 1-1-3 ratio currently applies to home video and pay TV, but the other residual formulas don't fall into this simple pattern.)

    I recognize your point about a weakness of my proposal being that residuals always increase, and clearly it will take some additional thinking to work through this. There's only so much one can do in 950 words and without access to proprietary data. The only data I have right now is a 6 or 7 year SAG chart and, indeed, residuals in all categories increased (in non-inflation adjusted dollars).

  7. Meant to sign the preceding comment

    - Jonathan

  8. Sorry for the delay in responding to your comment - I've been away. I pulled the 5% totally out of thin air. Just a convenient substitute for actual proportions. Frankly, I think it's probably not far off of what it should be but it's just a lob.

    I understand your point about "should" and "do" but I think one of the big problems here is the terrible lack of understanding about residuals in our industry. Most people I talk to who are members of the guilds don't have clear understandings of what they are receiving residuals on and what simple ideas like "gross" and "net" even mean. I think the situation with writers is particularly skewed because of their capacity to individually negotiate which cuts against the very concept of a guild's purpose as a collective bargaining entity.

    Anyhow, every proposal has it's holes, I just think that the arguments around residuals are built on massive misunderstanding of what residuals are meant to accomplish. The unions need to decide whether residuals are a tax on profits (the argument you hear from unions that 'you [the producer] keep profiting off my [the member's] creative output') or a way to even out the uneven pay cycles of talent. Once they have a sense of that there is a foundation for logical engagement.

  9. Fed (W)

    how unpleasant for you! anti-mf, jonathan handel, an entertainment attorney who follows this and writes about it closer than ANYONE in the industry, (you're not in the industry, or involved in either union fred. give it a rest) - NOW says:

    A. the sunset clause is a "joke"


    B. the residuals system should be some form of gross percentage across ALL platforms, electronic deposit, saving money, stopping multiple holdings and re-issuings.

    Now THAT is a smart idea!

    and yet, poor fred, so unlike your multiple DUMB ideas. only this time it comes from a fellow attorney actually IN the business IN hollywood who you can't dismiss out of hand.

    this is PROGRESS, and the industry will take NOTE.

    and that's a good thing.

    perfect? of course not. a VAST improvement and a sensible move forward into the 21st century, across ALL platforms?

    yup. your move fred. you might want to listen to people who actually know what they are talking about.

    matt mulhern

  10. Mattie (or is it Phil?),

    1. A disagreement between two informed people is never unpleasant. There is often much that can be learned from such an interchange, and it doesn't really require the use of CAPs to make a point.

    2. Jonathan Handel never called the sunset clause a "joke." It’s dishonest to suggest he did. He didn’t think it would be effective, but that’s something different.

    3. Jonathan Handel is an excellent lawyer. However, he would probably be the first to agree that he's not omniscient. When people deal with lawyers, there are usually two in a room. That’s why. There’s a difference of opinion on the sunset clause, and a difference of opinion on the future of residuals.

    In Mr. Handel’s article, he cited Schuyler Moore, another excellent entertainment attorney, and noted that Mr. Moore has suggested scrapping residuals entirely. This is what Moore said about residuals in February:

    “When residuals first snuck their nose under the tent, they were applied only to the then-tiny amount of TV revenue on theatrical films, since talent was paid their base compensation for the primary medium: theatrical. . .Residuals then were applied in the 1970s to another ancillary medium called video, which through an unexpected fluke grew into the main event and now swamps theatrical revenue by a margin of 2-1. The guilds conveniently have forgotten history and now think that residuals on the primary media are a God-given entitlement."

    Moore sees residuals as bad for business. I see residuals as becoming non-existent in a business model that generates little or nothing of the traditional revenue that residuals are based on, even the "gross percentage across ALL platforms." That makes them bad for performers.

    What's the appropriate percentage of zero, Mattie?

    5. My comments here point out the problem of basing a compensation scheme on a percentage of something that might not exist. This really isn't an original idea with me, and I'm not the only one concerned about it. All my clients are concerned about it.

    Just recently, on another blog, you came out in favor of a partnership between producers and actors in which the "partners" would share in the gains AND the losses from a production.

    This is a direct “quote” on how you would approach producers in a negotiation:

    "“we’re giving up an awful lot to allow you to avoid the previous costs to actors in development. So, how about we Do become partners, and share the gains AND the losses?”

    This idea goes a lot further than Handel's reorganizing the present system, and actually seems a rather simplistic take on Moore's earlier idea (not that you'd have any idea about that) about having residuals as a line item in the initial project budget, but it also seems to contradict the position you're taking here in supporting a plain vanilla residual system.

    Perhaps you can explain the inconsistency.

    I've worked in entertainment law for 20 years. I see the traditional means of compensation, all of which are tied to controlling distribution, collapsing now that distribution is uncontrollable. If my clients are going to get paid, we're going to have to find a new way of compensating those engaged in the creation of what we watch and listen to.

    Based on my experience, I don't think residuals are going to cut it in the long run. Mr. Handel disagrees. My comments in this column were directed to what I took to be a blind spot in Handel's reasoning, on which I drew on my experience in the music field, which has truly acted as the canary in the entertainment coal mine when it comes to making money. I hope he found my comments helpful. I'm a little disappointed that he hasn't responded directly, because he may very well be the one with evidence that supports reforming the current system over finding something new, but this is his playground and he sets the rules. The debate will just continue elsewhere.

  11. fred

    you lost me at "two informed people"

    why do you think some lawyer from nashville, not in or involved in either union, except for being fired by aftra in the late '80's for mismanaging a fund, has anything to add that anyone takes seriously?

    matt mulhern

  12. "You lost me at "two informed people""

    You were lost well before that, but I'm glad to know you finally noticed.