An Economic Analysis of Cineplex

Prepared by Christopher Dule Student #: 821-366-739 Subject: Microeconomics (Business) Instructor Name: Suzanne Iskander

TABLE OF CONTENTS
INTRODUCTION ........................................................................................................................................ 2 Purpose of the Report................................................................................................................................ 2 Scope of the Report................................................................................................................................... 2 BACKGROUND ANALYSIS...................................................................................................................... 3 The Main Economic Trends affecting the Economy ................................................................................ 5 Technology ........................................................................................................................................... 5 Convenience of Access ......................................................................................................................... 5 Piracy and Government regulations ...................................................................................................... 5 An Economic Analysis of the Film Distributor Industry .......................................................................... 5 General Market Structure: ..................................................................................................................... 5 Competition, Market shares, & Competitive Structure ......................................................................... 5 Main Cost of Production for the Exhibitor Industry ............................................................................. 6 Presence of a Close Substitute: ............................................................................................................. 6 Income Levels: ...................................................................................................................................... 6 Industry Elasticities in the Short Run ................................................................................................... 7 An Economic Analysis of Cineplex .......................................................................................................... 7 Market Power ........................................................................................................................................ 7 Major Influence on the Cost of Production for Cineplex ...................................................................... 7 Economics of Scale ............................................................................................................................... 7 Factors affecting demand for more movies ........................................................................................... 7 CONCLUSIONS AND RECOMMENDATIONS ....................................................................................... 8 Diversification Action ............................................................................................................................... 9 Financial Action ........................................................................................................................................ 9 Operating Action....................................................................................................................................... 9 Bibliography ............................................................................................................................................... 10

TABLE OF FIGURES
Figure 1: Market Share with Geographical Depiction before Purchase........................................................ 3 Figure 2: Market Share with Geographical Depiction after Purchase .......................................................... 4 Figure 3: Where each dollar of your Movie ticket goes................................................................................ 6 Figure 4: Graph of Table 2............................................................................................................................ 9

INTRODUCTION
Cineplex Entertainment LP was established to bring the world of motion picture entertainment to as many people as possible and to promote art & cultural enrichment in Canada. According to Cineplex, features of its core values are: (1) to be driven by the dynamics of entertainment; (2) strengthening the Cineplex brand; and (3) 3Ps People, Passion, Performance. These core features have helped Cineplex grow into one of Canadas leading entertainment firms operating the most modern and fully digitalized motion picture theatre circuits in Canada1. Cineplex has been able to become very profitable by keeping itself very advantageous most notably in its supplementary service of hospitality. Going to the movie theater has become a part of the human experience all around the world, and for almost a hundred years has been second nature to people as driving. According to Moving Picture World Journal in June 25, 1910, The poor despised moving pictures have at last received recognitionIt is the culmination of a long fought battle for the recognition of motion pictures as a legitimate offering to the human experience (Moore, 2008).

Purpose of the Report

The purpose of this report is to analyze the economic factors affecting Cineplex and the film exhibitor industry. Consequently, we will be able to forecast the direction of Cineplex and the film exhibitor industry. This forecast will be achieved by specifically analyzing Cineplex and the industrys characteristics including: Market power Cost of production Economics of scale and Elasticity Competition and Market share General market structure

And with the forecasted data, make recommendations that will help keep Cineplex competitive.

Scope of the Report

There are many economic factors that affect the firm exhibitor industry, some on a large scale and some on a small scale. This report focuses more on the main factors. They are: Digital Cinema Technology Initial production costs Government regulations Internet

www.cineplex.com

BACKGROUND ANALYSIS
In October 2013, Cineplex tried to increase its market share (See Figure 1).
Figure 1: Market Share with Geographical Depiction before Purchase

0.9%

0.1% 15%

Cineplex Theaters Empire Theaters 59% Landmark Theaters 5-Drive In Theaters

25%

The key developments were: 1. Cineplex proposed the purchase of 24 movie theaters in Atlantic Canada and 2 in Ontario from its closest rival at the time Empire theaters 2. Empire theaters, owners of the Sobeys grocery chain found it hard to compete strongly in either market because of competition from other grocers such as Presidents choice and Wal-Mart 3. This purchase would have made Cineplex a monopoly in Ontario 4. According to the Commissioner of Competition in Canada, the purchase of the 2 theaters in Ontario was unacceptable but took no issue to Cineplexs purchase of 24 Empire theaters in the Atlantic region because at the time Cineplex did not have a presence there2 5. Landmark and Cineplex resubmitted a purchase proposal that would have Landmark buying the 2 Empire theaters in Ontario as well as 20 Empire theaters in Atlantic Canada and Cineplex purchasing 24 theaters in Atlantic Canada (See Table 1)

http://www.mondaq.com/canada/x/270484/Antitrust+Competition/Divestitures+required+in+Canadian+Movie+Theatre+Merger

Table 1: Canada's Movie Exhibitors Operational Breakdown

Categories

Analyzing Firm

Direct Competition

Indirect Competition 5-Drive In Netflix

Firms

Cineplex

Empire

Landmark

Total # of Operating theaters in CA

161

71

n/a

Before Purchase In Atlantic Region 0

After Purchase 24

Before Purchase 44

After Purchase 0

Before Purchase 0

After Purchase 20

Before Purchase 0

After Purchase 0 n/a

ON, QC, & BC

127

127

n/a

In Western Region

10

10

31

31

n/a

Market Share after Empire purchase

59%

78%

25%

0%

15%

21%

0.9%

0.9%

0.1%

6. The ensuing purchase created a new landscape of market share in Canada (see Figure 2)
Figure 2: Market Share with Geographical Depiction after Purchase

0.9% 21% 0%

0.1%

Cineplex Theaters Empire Theaters

78%

Landmark Theaters 5-Drive In Theaters Netflix

The analysis of this report will be presented in three categories: (1) The main economic trends affecting the economy, (2) an economic analysis of the film exhibitor industry; and (3) an economic analysis of Cineplex.

The Main Economic Trends affecting the Economy

The Canadian movies and entertainment market grew by 1.3% in 2011 to reach a value of $2, 754.9 million (MarketLine, 2012). The entertainment market is made of three segments: Movies, DVDs & online movie streaming, and *music. Technology One of the key factors that contribute to the movie entertainment market growth is the cost reduction and benefits for film makers (Limited, 2013). The advent of digital cinema technology has drastically changed how film producers distribute films. The trend now in the market is the transmission of movies electronically from satellites. Convenience of Access Consumer tastes have slowly shifted and expectations for wider convenience of access have grown immensely as a result. With the creation of smartphones, Ipads, and tablets, consumers expect to be able to get entertainment wherever they are. With almost 15million Canadian owning smartphones3, distributors and exhibitors are scrambling to meet this demand. Piracy and Government regulations The drawback to technology and convenience of access is piracy, and therefore government intervention in the market place. As cheaper ways become available for customers to get access to entertainment from non-reputable sources, so do calls from the industry on the government to tighten copyright laws. Although, there is inconclusive evidence that online piracy actually affects the economy4, the government has never the nevertheless stepped in with legislation.

An Economic Analysis of the Film Distributor Industry

General Market Structure: The general market structure of the movie exhibitor industry in Canada is Oligopoly. This is because only a small number of firms control a majority of the market. This is very similar to the theoretical description because only two companies in Canada combine to have 99% of the market share. Economics of Scale is constant in the industry with an inelastic demand curve in the long run. Competition, Market shares, & Competitive Structure The major direct competitor to Cineplex is Landmark Entertainment. They have a very strong presence in Western Canada but negligible in other regions of Canada. Currently, Cineplex
3 4

http://ipsos-na.com/news-polls/pressrelease.aspx?id=6005 http://www.washingtonpost.com/blogs/wonkblog/post/how-much-does-online-piracy-really-cost-theeconomy/2012/01/05/gIQAXknNdP_blog.html *Music is being ignored because of the nature of the firm being analyzed

controls 78% of the market share, while Landmark controls 21% of the market share (see figure 2). Because of Cineplexs strength in the market, the competitive structure of the industry is very low, and therefore an inelastic demand curve in the long run. New entry into the industry is very difficult mostly because of the already established exhibitor network between Cineplex and most film producers. Main Cost of Production for the Exhibitor Industry The main cost of production for the industry is the licensing fee or royalty that has to be paid back to a film producer after agreeing to exhibit a certain film (see Figure 3). Although a movie company puts the money upfront that is used to pay the skilled/technical crew behind a film, that expense has to be made back. This is done by copyright licensing given to film exhibitors for the privilege of showcasing their product to consumers.
Figure 3: Where each dollar of your Movie ticket goes

Presence of a Close Substitute: The fact that the Canadian movies and entertainment market grew by 1.3% is good news for Cineplex as Canadas most dominant exhibitor, but one of the key factors in a firms ability to supply a good is the presence of a close substitute. In 2011, Canadian films grossed an estimated $880.1 million but its closest substitute, DVDs and online movie streaming grossed an estimated $1399.5 million (MarketLine, 2012). This means according to the law of demand that the quantity demanded of movies is slowly declining and downward sloping. Income Levels: The global economy crashed in 2011 and caused a change in peoples income levels. Although film exhibitors get a reasonable return on revenue from movie showcases, the majority of revenue comes from the sale of concessions at the theater5. Consumers cut back on normal items
5

http://www.thestar.com/entertainment/movies/2012/11/08/cineplex_profits_double_on_higher_priced_tickets_more_concession_sales.html

such as going to the movies and switch to inferior goods such as online movie streaming. In this context, we can reasonable conclude the concessions to be a luxury and complementary item of movie exhibitions. Industry Elasticities in the Short Run The price elasticities of the industry are quite large and very elastic in the short run. This is because of the availability of close substitutes such as DVDs & online moving streaming as well as smaller theaters showing movies for a niche audience (classic movies or independently produced movies) at a much lower price. Although, 5-Drive in theaters only have a 0.1% market share, consumers who want to save on big cinema concession costs and family movie nights sometimes seek this option.

An Economic Analysis of Cineplex

Market Power Cineplexs market power is very strong. With 161 operating movie theaters in Canada compared to 71 operating movie theaters from its now closest rival Landmark, it has a major influence on what products Canadian audiences see especially in Canadas most populous provinces Ontario, British Columbia and Quebec. Major Influence on the Cost of Production for Cineplex Cineplexs biggest cost of production in the short run is location to customers (like owning a location in Barrie), movie screens per theater, and licensing fee from film producers. In the long run, they can buy bigger movie theaters in more convenient locations (example yonge and dundas square), offer movies in IMAX & digital format rather than regular format and offer more hospitality services such as VIP cinema box seats. Economics of Scale Premieres and opening weekends are the best chances for exhibitors to make a significant portion of their revenue. The nature of a product, like all products is that once a customer is satisfied, the need to return is largely diminished. The diminishing marginal product for film exhibitors is 6weeks, in which case the demand for the movie begins to experience its diseconomies of scale very quickly. It is also important to note that Cineplex experiences negligible constant return to scale in the both short and long runs. Factors affecting demand for more movies There are two major factors affecting demand for more movies: (1) Classification of Offerings and (2) Consumer Tastes. In Canada, film ratings are a provincial matter. Currently, the Ontario

Film Review Board has 5 classification categories of movies6. This largely impacts the scale of operation by Cineplex, because original films might have a different classification in another province or country. This limits Cineplexs ability to determine its rage of showings, and therefore largely affects Cineplexs revenue. For example movies with a PG-13 rating from US are sometimes classified as 18A in Canada, thereby reducing the amount of people that can see it. Consumers like variety and options, and so expect movies of different genres. Online streaming gives consumers a wider range of choice from other geographical segments that Cineplex finds difficult to do. Cineplex offers undifferentiating products such as seven Harry Potter movie offerings, which changes consumer tastes very quickly.

CONCLUSIONS AND RECOMMENDATIONS

In the last three years, Cineplex has made substantial operating revenues7 and as such has been able to take command of the market. Its ability to enhance its flower of service in the area of hospitality has been exemplary. Cineplex has been able to wave off competition from foreign firms such as AMC & Famous players, and domestic firms such as Empire theaters. Based on this analysis, it is sufficient reason to conclude that Cineplex is a sustainable exhibitor firm. Although Cineplex has been able to become the most dominant player in the Canadian market, consumers have a tendency to switch, and the difficulty and price elasticity of switching from movie theaters to online streaming is very elastic. Netflix offers a range of genres such as anime, cartoons, kung-fu, martial arts, culture specific programs, and documentaries. Because of all the factors already mentioned such as income, consumer tastes, and close substitutes, the movie exhibitor industry and well as Cineplex is forecasted to decline (see Table 2 and figure 4).
Table 2: Forecasted Movie Entertainment Revenue and Growth Percentage
C$ Million - Revenue Forecast % Growth

2011

2724.1

1.3

2012

2681.4

-0.6

2013

2675.2

-0.2

2014

2668.9

-0.2

2015

2662.7

-0.2

2016

2656.4

-0.2

6 7

http://www.ofrb.gov.on.ca/english/page6.htm http://www.statcan.gc.ca/daily-quotidien/120207/dq120207b-eng.htm

Figure 4: Graph of Table 2

2740 $C Million - Reveuue Forecast 2720 2700 0.5 2680 0 2660 2640 2620 2011 2012 2013 Year C$ Million - Revenue Forecast % Growth 2014 2015 2016 -0.5 -1 1.5 1 % Growth

Supported by the findings and conclusions of this report, the following recommendations are offered in the form of actions to keep Cineplex competitive.

Diversification Action
1. More movie offerings. This would provide the customer more choice and draw customers to the movie theater on a regular basis. This will help to prevent a steeper diseconomies of scale 2. More movies for children. More children at the movie theater means more adults at the theater and therefore more revenue without lowering price.

Financial Action
1. Consider reducing concession price on Tuesdays. Cineplex has done well in the creation of half price movies value on Tuesday, but concessions are a complementary item and the law of demand dictates consumers want it low as well 2. Renegotiate royalty fees. Canada is a major market in the movie entertainment industry of North America and with Cineplexs new bargaining power in Canada, a renegotiation to lower royalty fees should be attempted.

Operating Action
1. Streaming Online. Cineplex offers DVD sales online but do not offer streaming movies. By offering customers a close substitute of the Netflix offering, Cineplex can capitalize on the demand of consumers for online content.

Bibliography
Limited, I. R. (2013). Global Digital Cinema Screen Market 2012-2016. New York: Infiniti Research Limited. MarketLine. (2012). Movies & Entertainment in Canada. Toronto: MarketLine. Moore, P. S. (2008). Now Playing: Early Movingoing and the Regulation of Fun. New York : State University of Press, Albany.

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