Arthur De Vany: Hollywood Economics

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Chris Hibbert

Arthur De Vany's Hollywood Economics gives a detailed look at an extreme example of a long-tail industry, the movies. The first half of the book consists of some technical papers that De Vany wrote during his career as an economist. Some of them are quite technical, but they lay the foundation for De Vany's contention that making movies is a highly unpredictable business.

These opening articles demonstrate that there is little predictability in the movie business, and investors, directors, producers, and actors who try to improve their odds by spending more money on special effects, hiring people from the A list, advertising heavily, or whatever else haven't studied the numbers well enough.

The old slogan "nobody knows anything" arises because of the nature of movie releases. Audiences vary from week to week, and they have an always changing menu of movies to choose from. Their reaction may depend on what's in the news, what hits have appeared recently, and whether the blockbuster that came out six weeks ago still has legs. And that's before we try to take account of the intrinsic merit of the story, the acting, how broad the distribution is, etc. Every week is a new tournament with some old and some new players. The audience can't make a judgment about any particular movie until they see it, and they don't make their evaluations from a clean slate.

The statistics deriving from this chaotic process produces the now familiar power law distribution. 70% of movies made are unprofitable, but the business makes money on the whole. most of the 30% that make money barely do better than breaking even; only a few a really successful, and the business of Hollywood is all about trying to make enough movies and give yourself enough chances that you can capture one of the few runaway successes. De Vany talks about how how studios, actors and directors should structure contracts so that the right people have the right incentives, and the right people make money when there is a hit. He then analyzes some actual contracts to show that they follow his rules: star players give up some straight pay for a share of the distant upper tail. The contracts talk about events that are meaningful for less than one movie in a hundred, but that's where all the money is, and one hit in that category can make you rich.

After he's laid the groundwork in the first half of the book, De Vany talks about the breakup of the Hollywood studio system at the end of the 1940's. I had no idea the anti-trust crusaders had even done this. The golden age of the Hollywood studio system was ended by a series of anti-trust cases (culminating in the Supreme Court) that denied the studios the ability to own movie theaters, and restricted the kinds of contracts they could write with independent theater owners. The result was that the studios lost certainty about being able to place the films they made, so they had to be much more careful in deciding what movies to fund, and couldn't plan a season's production coherently. De Vany shows how poorly the courts understood the movie business, and that they didn't achieve any of their objectives in terms of making the business fairer for independent distributors, theaters, or production companies.

I found the book to be fascinating, though quite dense. If the technical analysis in the first half of the book seems daunting, I recommend skimming it; just pay attention to his conclusions, since you'll need them to appreciate the findings in the second half of the book. I suspect there are many lessons that are applicable to other people trying to make money in other long-tail businesses. (Most of the discussion about long-tail is about making money by exploiting the long thin tail, but someone's making money from the tall, rich head of that curve.) The dynamics of other businesses are different, so you'll have to figure out what the drivers are for your uncertainty. De Vany does a great job of explaining the vagaries of the movie business, but not every business is an iterated tournament in which some of the contenders are new each week, while others have advantages or disadvantages due to their recent performance. There's a limit to the number of movies that can be playing in first run theaters every week, so some have to be dropped in order to make room for the constant flow of new releases.

I found this book after reading De Vany's blog for a while in 2005 and 2006. His articles on the movie business were quite interesting, but there's also a bunch of interesting material on evolutionary fitness, health, and sports.

Rich Dad's Guide to Investing

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Chris Hibbert

Robert T. Kiyosaki's Rich Dad's Guide to Investing isn't particularly well written, but it contains a fair number of good ideas. The prose is repetitive, and many of the ideas have appeared in other books in the Rich Dad, Poor Dad series. Nevertheless, I found it valuable. The subtitle ("What the Rich Invest In, That the Poor and Middle Class do not") indicates some of what I found in the book.

For a couple of decades, I was a pretty dedicated mutual fund investor. I read the (popular technical) literature, and understood the predominant returns of index funds, and the value of diversity. I continue to subscribe to the No Load Fund Investor newsletter, and use their recommendations to balance the portion of my portfolio that isn't in real estate.

But over the last few years I've moved most of my investments to real estate. The real estate group I've joined does an excellent job of providing education in the fundamentals of real estate investing. I feel competent to evaluate the value of an investment, the likely cash flow and prospects for appreciation. But it's clear that there is a lot more to learn, and many other kinds of investment projects to consider.

The Rich Dad series does a good job of explaining the basics: how to think about cash and cash flow, why real estate investment pays off whether the market is going up or going down, how the tax advantages work, etc. The books share similar stylistic problems; they're repetitive, anecdotal and simplistic. But there's good information in the books, it's not just hype, and if you pay attention, the books do give useful ideas on how get started and to proceed. It helps a lot to have decent classes to fill in the gaps. (If you're in Silicon Valley, or the L.A. area, I can recommend a group that gives informative classes, without hard sell or hype. Selling is strictly segregated from educating. The education tells you why and how and gives you an opportunity to talk to other people who are going through the same thing.)

This book primarily covers investor psychology and how to approach the process of evaluating, buying, and managing investments. Kiyosaki wants to convince people to have a long term view of their financial holdings, to evaluate potential investments for their effects on your cash flow, and to focus on investments that add to your net worth. The first half of the book concentrates on who you have to become in order to be a successful investor. Each chapter ends with a "Mental Aptitude Quizzes" to help you figure out whether you're serious, calm, patient, etc. enough to succeed at investing. The argument is that many people aren't temperamentally suited to being high-stakes investors, and they'd be better off trying something else.

Kiyosaki's main story about growing as an investor is that you need to start with a solid financial foundation so you can afford to take some risks, then you can either grow a portfolio slowly over time, or you can invest your effort into building a business on your own. The latter route provides many tax advantages while building the business, and gives more control over your life and the kinds of projects you invest in. He strongly emphasizes the value of building your own business (even a franchise business) both for the experience in what it takes to make a business succeed, and for the tax advantages. He overemphasizes the chances of building a successful business; he may be right that it's worth it for the experience.

One of his messages is that the safe way to build wealth is to "find a plan that works, and stick with it." Unfortunately, he repeats this mantra without explaining how to pick a good plan or how to tell whether your plan is working. There's a three-page section in Chapter 8 that talks about how to evaluate results, but I doubt that many readers will get it. It's not enough to have a plan and stick to it. You might be lucky enough to pick the right plan, or you might not. What you need first is a method for evaluating plans and their results. Then you can search for good plans, and experiment with them until you find one that works in practice for you.

Another message that is repeated many times is that employees are at someone else's mercy, while people who build successful businesses are in control of their fate. He pounds on this point to convince readers that being an employee isn't a path to wealth or security as most of our parents were taught. Aspiring investors need to be aware that getting loans is the most common path to buying real estate, and lenders like to see stable income. A failing business or intermittent consulting doesn't inspire their confidence. Once you have an investment portfolio, you can go to other sources for leverage, but when starting out, it's quite valuable to continue working the day job.

Different kinds of investors ( accredited, qualified, sophisticated, inside, ultimate) have different opportunities available to them. Moving into a new category requires learning the skills to evaluate the opportunities or gaining the resources to handle setbacks. Investing outside of the categories you are suited for is sometimes illegal, and usually (financially) dangerous. The tax treatment of income is different depending on whether it is from employee, self-employed, Business owner, or Investor. Sophisticated investors understand the tax treatment of each, and use each category when it is advantageous.

In the first chapter, Kiyosaki talks about the abilities of different kinds of investors:

There are many more bad deals than good deals. If a person is not aware, all deals--good and bad--look the same. It takes a great deal of education and experience to sort the more sophisticated investments into good and bad investments.

Reading this book is a small step in learning to distinguish good from bad. If you haven't decided that getting wealthy is worth the effort, you may not get much out of this book. If you have, there are important insights available here.