“Growth options” to produce a sequel enable studios to dedicate a larger budget to the original film, writes Wim Van der Stede

Van der Stede, Wim

Van der Stede, Wim A.

LSE Research Online

blogs.lse.ac.ukhttp://blogs.lse.ac.uk/businessreview/2015/09/10/hollywood-studios-appear-to-plan-sequels-before-they-produce-the-original-movie/Hollywood studios appear to plan sequels before they producethe original movieThe recent box office success of Jurassic World, the latest Jurassic Park sequel, reminded me of my study aboutthe use of real options in the motion picture industry*, which examined the application of this accounting tool tomovie sequels.A real option is the right, but not the obligation, to undertake a business decision. More importantly, a real-optionsapproach to investment and decision-making recognizes that managers invest in projects in stages, based onnew information. They can either continue or abandon projects based on how uncertainty unfolds over time. Thisis unlike traditional capital budgeting approaches and investment analyses that assume that managers undertake‘discrete’ investments rather than doing them in stages.In our research, we considered growth options in light of sequels following a successful original movie, as well asabandonment options, in the context of advertisement spending, indicating whether and how much to continue toback a movie based on such information as opening box-office receipts and tracking data. In this blog post, Ifocus on the growth option related to sequels.A sequel presents an investment option for a later time, based on an assessment of the originalmovie’s success.A sequel presents an investment option for a later time, based on an assessment of the original movie’s success.Sequels present lower risk for the studios because moviegoers are familiar with the original movie’s charactersand context. Unsurprisingly, then, many of the recent box-office hits were sequels, Jurassic World chief amongthem. This latest iteration of the Jurassic brand broke box-office records during its opening weekend, taking in$209 million in America and becoming the first release to surpass $500 million in total in a single weekendworldwide. The movie went on to eventually gross over $1.5 billion worldwide, over 10 times its cost.We had two key findings in our study. We first compared sequels with single originals (those that didn’t havefollow-up movies), and found that sequels earn a higher return on investment, which indicates that they are moreprofitable. Then we compared the two types of originals, with and without sequels. We found that studios incurhigher production and marketing costs for originals they plan to follow up with sequels, compared to those thatremain single movies. This result suggests that the value of a growth option in a sequel justifies higher costs foran original film. Moreover, these findings indicate that studio managers have a growth option in mind whenplanning the original.This was also corroborated through interviews with industry executives, who indicated that, in today’senvironment, they plan the majority of their movies with growth potential in mind. Of course, what we would haveliked to observe, but couldn’t, is originals for which a sequel was planned but never came out; i.e., cases in whichthe sequel was an unexercised real option. If these originals, too, have higher production and marketing costs,then that would further strengthen our inferences.Real-options approaches are a valuable tool that can be just as pertinently applied to capitalinvestment decisions in a variety of settings — such as the pharmaceutical industry, to name one.Some recent comments I have read about Jurassic World, which triggered this blog post, suggest real optionsthinking consistent with our study’s findings. Given its box-office success, and Director Colin Trevorrow’s hint thatJurassic World had “left story possibilities open” that might allow the dinosaur drama to play out in locations otherthan on an island, I bet that there will be another one.But what would be interesting, too, is to see sequels to our study, and not just related to motion pictures, as Ireckon real-options approaches are a valuable tool that can be just as pertinently applied to capital investmentdecisions in a variety of settings — such as the pharmaceutical industry, to name one — that demand massiveinvestments under huge uncertainty.* See also Using real options to make decisions in the motion picture industry.Featured Image Credit: Counse CC-BY-2.0Wim A Van der Stede  is CIMA Professor of Accounting and Financial Management, and Head ofthe LSE’s Department of Accounting. His research interests pertain broadly to the study ofmanagement control systems; i.e., the study of performance targets and the budgetingprocesses used to set them; performance measurement and evaluation; and incentive systemsthat relate performance evaluations to the provision of rewards. He tweets at @stede_w.Copyright © 2015 London School of Economics

Hollywood studios appear to plan sequels before they produce the original movie

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