Last Friday, I spent $14 on a movie ticket and it got me to thinking where that money goes. First, the theater takes its 50% cut, or $7.   After that, production costs such as union-inflated crew wages, location fees, and wardrobe account for 23%, or $3.22. Only about 14%, or $1.96, goes to the actors to which I most closely identify the movie.  With all these hands in the cookie jar, it's no wonder why movie ticket prices have increase 1.5 times faster than the general rate of inflation since 2001.

MBA Jargon Demystified

Hollywood in Brooklyn?: The Real Reason the Movie Industry Packed Its Bags for the West Coast

Today, the Los Angeles neighborhood of Hollywood is synonymous with the film industry the world over; 100 years ago it was a dusty agricultural settlement with no ambition to be the world's media hub.  That all changed in the Fall of 1911. 

For all intents and purposes "Hollywood" should still be centered in New York where Edison Studios, The Eastman Kodak Company, Kalem Company, and many other film production companies and key suppliers were located.  Furthermore, if you compare the economies of New York and Los Angeles after the first decade of the 20th century, there is seemingly no explanation for film's production and distribution to have moved.  New York enjoyed a large port that remained free of ice throughout the year and was several days closer to European markets than the port of Los Angeles.  The population of New York - 4.5 million strong - consisted of more skilled manufacturers, bankers and lawyers than LA's, which numbered only 500,000.  Capitalists, individuals whose net worth exceeded $10,000 (or about $245,000 in today's dollars), preferred residing in New York over LA by a 11 to 1 ratio.  New York also had the distribution advantage with 6 times more train cars traveling from its stations than its west coast counterpart.  However, Los Angeles had the deck's one wild card: the Ninth District Court of Appeals. 

A cartel of the industry's most important patent-holders formed in New York in 1908 under the name the Motion Picture Patent Company (MPPC).  By pooling 16 patents relating to film projection equipment, cameras and the Latham Loop, the 10 companies formed a trust hellbent on legally attacking any other company from producing, distributing or exhibiting film. Thomas Edison's choke hold on the infant industry reached a boiling point and by 1911 would-be competitors were searching for a friendly court to give them haven from Edison and his trust's patents. That haven was the Ninth District Courts of Appeals, who governed over the court systems of Los Angeles and took a less hardline approach on patent protection.  It was this factor, not the often cited good weather one, that allowed Los Angeles to benefit from being the home of Hollywood.

Under the Sherman Act, the Federal government eventually broke up the film industry trust in the United States v. MPPC (1915) Supreme Court ruling, but the damage was already done.  A handful of non-MPPC studios had already set up small production companies along the streets of Hollywood.

You can't help but wonder if not for the patent-busting judges of the Ninth District Courts of Appeals would the plots of land on Melrose Avenue, Culver Boulevard and Pico Avenue still be producing bananas and strawberries instead of the billion dollar film and television franchises?

Extending Credit – How Firms Quantify the Net Effect of Switching from Cash in Advance Terms to Open Credit Terms

By Jay Karimi

So your company is considering extending net 30 day terms to your customers instead of requiring them to pay for their orders in advance or on delivery?  There are a plethora of costs that will be incurred as a result of this switch, such as, the cost of hiring a full time credit and collections manager, the cost of bad debt (you won’t collect 100% of your receivables), cost of short term financing, and the opportunity costs.  With this onslaught of additional expenses, is switching your credit policy worth it?  

YES!

 That’s the short answer; the long answer is that the customers buy considerably more when they don’t have to pay right away.  As long as you have an effective credit and collections department and access to reasonably priced short-term financing, selling on credit terms is your best bet.  If you’re skeptical, here’s mathematical proof:

            NPV = - (C/r) + [(AR / r) x (1 – d)]

where, AR = additional revenue, d = probability of default, r = required return and C = cost of credit policy

To flesh out this formula, let’s assume LazyMan Film Equipment Rentals will experience a 20% increase on its $1 million annual sales when it switches to an open credit policy.  They will hire a full time credit and collections manager for $55,000 a year plus $10,000 in her benefits and employment taxes.  There will also be $5,000 a year in corporate credit agency subscriptions.  The industry average yields a 5% default rate and 2% required return. 

Annual sales w/o credit = $1,000,000

Annual sales w/ credit = $1,200,000 (20% bump)

Additional sales = AR = $200,000

Probability of default = d = 5%

Required return = r = 2%

Cost of credit policy = C = $70,000

Plugging in the numbers into our formula provides:

NPV = -(C / r) + [(AR / r) x (1 – d)]

       = -(70,000/.02) +  [(200,000/.02)  x (1 - .05)] 

{Note: both the additional annual revenue and annual cost of the credit policy are treated as annuities from the current year until forever}

       =  6,000,000

The firm should pursue an open credit policy because it is worth $6 million in today’s dollars (Recall that firms should accept any project with a positive net present value since it will ultimately add value to the shareholder). 

To calculate at what point the probability of payment default is too high to pursue an open credit policy, we can set the above equation to zero and solve for d:

0 = -(70,000/.02) + [(200,000/.02) + (1 – d)]

d = 6.5/10

d = 65%

In conclusion, as long as you expect to collect at least 35% (1 – 0.65) of your account receivables, this project will have a positive net present value and should be pursued.