Wednesday, November 21, 2007

Residual Thoughts on the Writers' Strike

The big elephant in the writers’ strike is the issue of residuals for “new media,” such as online sales and (at least until they were taken off the table) DVDs. Now, it’s completely understandable that writers would want a share of the new revenue streams. If the new revenue sources constitute an increasingly large slice of total revenues, then an old contract based on residuals from sources that are drying up (like VHS sales) will give writers a diminishing share of the gains from trade.

But there is more than one way to give writers a share of a revenue stream. Residuals are one way. Alternatively, we could calculate the expected present value of a stream of residuals, and then tack that amount onto the up-front payment for a writing job. Put simply, the choice is between (a) a smaller up-front payment plus residuals, or (b) a larger up-front without residuals. In expected value terms, the two are equivalent if the calculations are done right.

The equivalence between (a) and (b) doesn’t mean it’s a matter of indifference which is chosen. Arguably, method (b) is superior. It would allow better compensation for both writers and producers, for at least two reasons:

1. After a project is in the can, the writer has little or no further input. Producers, on the other hand, still have considerably input: they can set the price for sales of the product, decide the appropriate amount of marketing, and so on. So the important thing is to get the producers’ incentives right. Residuals paid to writers are like a tax; they reduce the producers’ benefit from pushing the product. They will thus invest less effort in promotion than they otherwise would. Get rid of the residuals, and the producers will market and price the product so as to maximize its net value. That means a bigger pie, a portion of which can be paid to writers in the form of even larger up-front payments.

2. Residuals, being dependent on future sales, are inherently more risky than up-front payments. Writers, like most people, are probably risk averse. Producers, on the other hand, get their funds from investors with diversified portfolios (of entertainment products and other investments), and they are thus closer to risk neutral. Moving from the residuals (a) to the higher up-front payments (b) would shift risky assets – uncertain future revenue streams – onto the more efficient bearers of risk. Meanwhile, the writers would get the equivalent of an insurance policy.

I’m hesitant to conclude that the residuals system is definitely inefficient, because its longevity in the entertainment business provides some evidence of its utility. Maybe there’s some other factor at work I’m missing that would make residuals desirable. In talking to writers and others in the industry, though, I haven’t found a convincing argument yet.

One friend pointed out, correctly I think, that residuals have a historical legacy that goes back to an era when writers had more control over the distribution of the product. For instance, Shakespeare wrote plays and directed the Globe Theater. This history has contributed to a notion that writers should get a share of all future revenue from their creations. But while this story may help explain where the residual system came from, it doesn’t show that it’s efficient now. Shakespeare was both a writer and a producer. We have now progressed to a system of greater division of labor, in which some people do the creative work while others provide the financial backing, distribution, etc. The real issue for writers should be whether they are compensated in a manner that induces them to do good work; if an up-front payment does that while providing better incentives to producers, that’s the way to go.

The best argument for residuals I’ve found so far is this: Writers are trying to guarantee themselves a certain share of the gains from trade. Because residuals are defined as a percentage, their size will rise and fall with the total revenue generated by the product, and thus writers will still have about the same (percentage) share regardless of what happens to the industry. If overall revenues rise, writers’ compensation will also rise; if overall revenues fall, writers’ compensation will, too. This is more difficult to guarantee with fixed up-front payments, although I’m guessing someone could devise a contractual formula for up-front payments that achieved the same effect. In any case, residuals serve this function effectively only if the contract specifies the right revenue sources. If the sources change, as happened after the last contract, then the writers’ share dwindles. What happens if the new contract specifies generous residuals for online downloads, and it turns out the next big thing is wireless direct streaming to the cerebral cortex, or some other delivery method we can’t even imagine? Remember, nobody foresaw online downloads, either. Up-front payments, on the other hand, have to be paid regardless of the eventual revenue sources.

I have one other possible justification for residuals in mind, but I haven’t fully worked it out yet. In the meantime, I invite readers to suggest other arguments for residuals – or further support for my suspicion that higher up-front payments would be superior – in the comments section.


Jadagul said...

There's an argument I've heard a lot that can't be made explicitly, but seems implicit in a lot of what people are saying. Specifically, I've heard a few times that "Writers go for long spells without getting any new jobs, and residuals guarantee that they have some sort of income until the next contract."

The implicit argument here is that writers are very bad at projecting future income, and bad at disciplining themselves to err on the safe side of their savings rates. So if all payments to writers are lump-sum, they'll overspend and then have periods of no income and no savings. The residuals model forces them to take some of their compensation as deferred income, and thus guarantees that the writers will always have some sort of resources.

Also, no matter how we say that it acts as risk reduction, a lot of people think it seems incredibly unfair that the writer of a hit show doesn't make tons of money, even if it's because he's insured against having a bomb that makes him nothing.

Anonymous said...

This was a very interesting and thoughtful post of yours. I like your lump sum idea, and I can't see why it shouldn't be a viable option. I can imagine though that for productions on a tight budget, producers/investors may prefer the residual method of compensation to avoid having to shell out the extra money upfront.

Tim Worstall said...

One possible route of enquiry is to look at where writing contracts are in fact lump sums.

A lot of newspaper Op/Eds for example, or ghostwriting of books (in the latter, a flat fee is paid to the writer, the celebrity taking the royalty risk).

There's also a whole lot of low end book writing work that operates on a flat fee structure.

Certainly, from my point of view, as someone who works as a writer at the intersection of these two models (some work is flat fee, some is advance and royalty based) the general perception in the industry is that royalty based is more desirable. Indeed, you need to have something of a "name" or an amazing product before you're actually offered royalties.

Ran said...

If there's a standard contract for writers (and it seems like you're saying there is?), then it seems that residuals are the only way for this to work, since obviously different writers deserve different compensation based on how much expected benefit their participation brings to a project (whether through their skill, or simply through name recognition), and a standard per-project up-front couldn't take this into account.

Put another way, the expected present value of the stream of residuals depends on the writer (and for that matter on the project), and therefore option (b) cannot be achieved by a standard contract.

Glen Whitman said...

Jadagul -- I agree, I think that's one of the "can't be stated aloud" arguments. It sorta makes sense, except that an uncertain revenue stream doesn't make a very good savings plan. Also, if that were the real concern, the guild itself could allow, or even require, its members to contribute part of their up-front payments to some kind of personal unemployment fund.

Tim and Ran -- To clarify, what the guild does is set a "guild minimum," which covers both up-front payments and residuals. Writers are free to negotiate higher-paid contracts, as long as both minimums are respected. Also, writers can be added as producers; that's another way to give them a piece of the revenue stream. So while it's true that some big names might prefer to have the residuals, a guild minimum without them would not prevent such arrangements. The minimum is most relevant to people at the low end, who are analogous to the book writers Tim says get paid by flat fee.

Anonymous said...

I was thinking about this exact thing this morning, and I think a reason that producers would favor residuals is that it gives the writers an incentive to write something that will be commercially successful instead of "artistic." They would have to write something that actually sold instead of just convincing producers that it would sell. This would seem to put actual writers and producers on exactly the wrong side of the argument though, so I suspect I'm missing something.

Anonymous said...

An obvious reason for a lump sum payment is that it reduces monitoring costs, particularly when the residuals consist of a share of profits, or even revenues less marketing costs.
The countering argument is that it puts artists in the estimation business in order to calculate a fair market value, which they probably aren't as good at as their corporate overlords.

Dr. Zeuss said...

Very interesting post.

"...they will invest less effort in promotion than they otherwise would"
Might less promotion be a good thing, considering that producers don't pay the costs that promotion imposes on whoever they might beat out as a result? (Asuming the advertising game is zero-sum, which it probably isn't, but.)

Anonymous said...

Residuals may provide an added safeguard for child actors. Jackie Coogan's fortune earned as a child star was wasted on drugs by his parents, even though he was successful later in life as Uncle Fester on TV. Laws were passed in the 30's in California to prevent a recurrence of this type of theft, but it still happens. Witness the case of Gary Coleman whose parents took advantage of his millions supposedly leaving Gary close to broke. My guess is that he still gets residual checks, which is a good thing.

Anonymous said...

I assumed that writing contracts offered royalties for the same reason that oil and gas development deals pay royalties. Hard to know just how much of a resource there is to develop - it can't be judged completely ex ante - so it allows the seller and buyer to share some of the risks.

Presumably, the studio is in a better position to manage risks than writers, so maybe the risk sharing explanation doesn't satisfy.

My second thought is that it reduces negotiation costs that would otherwise stymie many deals. Writer thinks his work is worth its weight in platinum, studio says "tin." They settle on giving the writer a nickel for every dollar of sales, which turns out to be on the platinum side if the writer is correct, and closer to tin if it is a dog.