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Paul Ormerod: March 2012

Saturday, 24 March 2012

Why do films flop?

The Disney sci-fi flick John Carter has become one of the biggest flops in movie history. The studio has announced that the film's theatrical run will lose $200million.

There has been a huge amount of comment in the media about why this happened. On Yahoo!, for example, several reasons were put forward. For example: the advertising campaign was bland; Taylor Kitsch is not a leading man; the title was wrong; the reviews were bad.

Other huge loss makers have figured in the discussion. In 2011, Mars Needs Moms lost $110million. Sahara in 2005 and Green Lantern in 2011 both had strong lead actors, and both grossed takings well in excess of $100million. But the costs far exceeded this, and both lost over $100million.

There is a long list of massive failures going back many years. Ex post, once the film has failed, many reasons are put forward to explain why it happened. Ex ante, however, in every single case, the producers believed the film would make a profit and not a huge loss. And commentators who seem so erudite in explaining failure after it has happened rarely, if ever, succeed in making a successful prediction of the failure.

There will be specific reasons associated with each failure. But there is a much more fundamental reason, deeply rooted in how popular culture evolves. ‘Popular culture’, incidentally, does not refer simply to films, music, or television shows. Performances of Wagner’s Ring Cycle at Bayreuth have on occasions been very badly received by the highbrow audience.

Even though the people at this festival by definition are devotees of Wagner, even though they adore Götterdämmerung as an opera, until they have seen this particular performance, they do not know whether they will like it or not.

More fundamentally, their opinions are shaped not just by their own personal evaluation, but by the reactions of others in the audience. Someone may feel the performance was rather good, but he or she can observed directly the reactions of others immediately around them, and can hear the general reactions across the audience as a whole.

In the same way, people react to films, spreading their opinions by word of mouth and by blogs.

Positive feedback, the response to how everyone else is reacting, creates massive inequalities of outcomes in film successes and failures. And this may be only tenuously related to the objective attributes of the film, such as the presence of stars or whether it has a good story.

The American economists Arthur De Vany and W. David Wallis published an article in the Economic Journal in November 1996, using a formal mathematical model to account for success or failure in the American cinema and testing it by comparing its properties with those of the weekly data provided by Variety’s Top 50 films in America. The principle of positive feedback operates with devastating effect. During the nine months which they analysed, the top four films took over 20 per cent of all box office revenues, and the bottom four less than one hundredth of one per cent.

But the process of the evolution of preferences to a popular culture offer such as a film involved inherent, massive uncertainty, which no amount of pre-planning can overcome. People do not have fixed tastes and preferences, as economic theory assumes. They evolve over time, and they do so in part in response to the choices and decisions of others.

Wednesday, 21 March 2012

Corporate structure, Darwinism and Random Selection

The corporate world exhibits a wide variety of structures. Co-operatives and partnerships have been around for a long time and have some well known examples. The Co-op, for example, was founded in Rochdale as long ago as 1844 and now is represented worldwide. Goldman Sachs was a partnership for most of its existence. There are more exotic forms of the corporate beast, such as companies limited by guarantee, industrial and provident societies, friendly societies and, recently made possible by legislation in the UK, community interest companies.
But by far the dominant form of corporate organisation is that of the joint stock company with limited liability. In other words, companies ultimately controlled by shareholders. These can range from one person bands to the world’s largest firms such as Google.
Although the concept had been around for a long time, the shareholder company came into dominance in the corporate world in the late 19th century. It remains by far the single most important form of corporate structure, even if we count the frequencies of the various structures on a simple head count rather than by value or turnover.
Companies run by managers on behalf of shareholders are coming in for increasing criticism. In the financial crisis, the value of the equity of many banks collapsed and shareholders were sometimes left with nothing at all. But in the process, the managers had enriched themselves. The issue of the pay of senior executives in such companies remains a very live and sensitive political issue.
Is it time to call a day on this form of organisation, and if so how is it to be done?
A lot depends on why we think this particular structure came to exercise such dominance in what we might think of as the ecology of corporate organisation. Many different forms of organisation compete to be adopted by entrepreneurs setting up in business. But it is the shareholder company which is by far the most frequent choice.
If we do a simple plot of the relative frequencies with which the different types of structure are observed – even on a simple head count – we observe a highly skewed outcome. Huge numbers of shareholder based companies, a lot of partnerships, but far fewer than the number of the ‘market leader’, some co-ops, then fewer and fewer until we get down to recent innovations such as the community interest company, with very few examples.
Pure Darwinism would lead us to believe that the shareholder company is dominant because it is better suited to the environment, to the ecology of corporate structure. It is somehow fitter than its rivals. Selection by fitness, however, does not by itself account for the relative frequencies with which we observe the different corporate forms.
A quite different theory also comes from biology, to account for the frequencies with which different species are observed in any given ecology. Stephen Hubbell, based at the University of California at Los Angeles, came up with the so-called ‘neutral’ theory, which generates results which conform to the outcome which we observe empirically in ecological systems. A few species have lots of members, most species have very few. Exactly what we see with corporate forms.
A plausible hypothesis is that, in any given system, rare species are rare because, for whatever reason, they have not adapted well to their environment. Similarly, abundant species must have particular attributes which enable them to flourish. But the word ‘neutral’ in this context means that no species has any special qualities or characteristics which make it more or less suitable to operate in its given environment. Their relative success or failure is ‘neutral’ to their attributes. In other words, how a species behaves, what it can and cannot do, is irrelevant to whether or not at any point in time its numbers are small or large. The outcomes which we observe are the result of purely random processes.
It is a disturbing theory, which appears to defy common sense. But common sense tells us that it is the Sun which goes round the Earth and not vice versa. We see the Sun move, but we seem to stay still. It has the great strength that it fits the facts. Yes, evolution takes place, but the eventual outcome and the eventual ‘winner’ are determined much more at random than by inherent fitness.
The policy implications of this are important. If we think the neutral theory applies in any serious way to corporate structures, the way to remove the dominance of the shareholder company is to allow more innovation, to allow different forms to come forward, one of which will eventually replace the dominant species.

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