Viewpoint: SAG should do the new math, and then do a deal

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As sag negotiations drag on over the hot-button issue of the calculation of residuals on VOD, it is worth taking a closer look at the recently inked agreements with the DGA and WGA -- especially because the studios are offering SAG the same deal and the actors aren't buying it.

Residuals always have been calculated "at source," which in layman's terms means one step back from the consumer -- that is, the amount paid by the entity that receives money from the consumer to the next link in the chain (usually the studio). For example, residuals on DVD revenue are calculated based on the amount that the retail and rental video stores pay to the studio, not on the amount that consumers pay to the retail or rental stores. In short, the revenue on which residuals are calculated is much lower (on average about 60% lower) than the amount consumers pay.

The most irksome aspect of the calculation of residuals to the guilds is that only 20% of the "at source" DVD revenue paid to the studios is included for purposes of calculating residuals. So, if a studio receives $100 of DVD revenue, only $20 of it is included as the starting point for calculating residuals.

The previous guild agreements did not clearly deal with VOD revenue, so it was unclear as to (a) what revenue stream should be treated as "at source," and (b) whether VOD should be analogized to DVD, in which case only 20% of VOD revenue should be included for purposes of calculating residuals.

Which brings us to the recent DGA and WGA negotiations.
Predictably, the studios' opening bid for VOD was that (a) the at-source calculation should be based on what the VOD company paid the studios (not the greater amount that the VOD company received), and (b) residuals on VOD revenue should be treated in the same way as for DVD revenue.

The net result of the negotiations was a new DGA agreement followed closely by a new WGA deal -- both of which accept the studios' position that the at-source calculation should be based on what the VOD company pays the studios (not the amount the VOD company receives) but both of which provide that 100% (not 20%) of the VOD revenue paid to the studio should be included for purposes of calculating residuals.

The trade-off for this 100% inclusion of VOD revenue paid to the studio was that there is a reduction of the actual residuals rate from the rate applicable to DVD revenue by about one-third for VOD rental revenue and by about two-thirds for VOD sell-through revenue. However, this rate reduction is more than made up for by including 100% of VOD revenue paid to the studios.

So what? You can barely buy a decent lunch with VOD revenue from a film these days, so who cares? And this probably is why the studios agreed to the new calculation.

But as sure as day follows night, and as sure as iPods are replacing CD players, VOD eventually will replace DVDs. In only a few years, DVDs will be dead and buried, replaced by a smorgasbord of VOD alternatives, including subscription, rental and download to own. And just as DVD is now the single largest revenue source for films, so shall be VOD. In its wake will be the new residuals calculation based on 100% of VOD revenue paid to the studio.

Let's do the math for the DGA and WGA combined:

> DVD: Assume that consumers pay $1,000 for DVDs for a film. Assume that the retail and rental stores pay a combined current average of about 60% of that, or $600, to the studio. Only 20% of this, $120, is subject to DGA and WGA residuals at a combined rate of about 3.6%, for a total residuals payment of $4.32.

> VOD: Now assume that consumers pay the same $1,000 to a VOD rental service like Movielink which again pays about 60% of that, or $600, to the studio. The new combined DGA and WGA rate is 2.4% for VOD rentals, for total residuals owed of $14.40 -- more than three times as much as for an equivalent amount of DVD revenue. (The residuals rate is lower for VOD sell-through, but it still works out to residuals almost two times more than for DVDs.)

So if I were the SAG hierarchy, I'd say to my members, let's sign on the dotted line now and go home and gloat before the studios take a hard look at the new math. And rest assured that every agent in town will quickly figure it out and insist on the same calculation for the separate contractual participations for talent.

In the VOD future that is coming, the combination of residuals and participations may add up to a world of hurt that the studios may come to regret. So, actors, grab what they're offering now.

Schuyler Moore is a partner at Stroock, author of "The Biz" and an adjunct professor at the UCLA School of Law and the UCLA Anderson Business School. He can be reached at smoore@stroock.com.
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