The recent news that exhibitors in North America and Germany were unhappy with the film rental terms Walt Disney Studios was offering for their release of “Avengers: Age of Ultron” provides a perfect opportunity to explain some longstanding industry practices associated with theatrical film booking. A little background might help clarify Disney’s motives and what cinema operators are so concerned about.

The Wall Street Journal first reported North American theatre owners were upset over the film rental terms for “Avengers” Tuesday morning, hours before the Walt Disney Co. held a conference call to report their second-quarter earnings. The dispute began earlier this year when Disney began negotiating a new master licensing agreement with North American exhibitors. Just about every major distributor uses such agreements as blanket deals for all of their releases during an assigned time period, usually a year or two. In part, these licenses outline a standard set of terms under which an exhibitor will play the distributor’s titles at each cinema it operates. While film rental terms are negotiated on a per-picture, and at times per-theatre basis, the master licensing agreement serves as “starting point”.

There were at least three major sticking points in the latest licensing agreement Disney presented to theatre owners. The first dictated the hour in which a theatre must stop offering matinee discounts to patrons; any showtime after 5:00 pm local time. That is an hour earlier than the 6:00 pm exhibitors have traditionally agreed upon with distributors.

The second issue had to do with what is known as “splits” or “split screens”, which is when a cinema operator will book two films on the same screen, either alternating their showtimes, or programming one to play during the day and the other in the evening. The circumstances in which a film gets split vary, but it often occurs when a title nears the end of its run or an exhibitor wants an extra screening or two of a popular release for overflow purposes. A split screen is also used to program a film which won’t garner an audience at specific times of day, e.g. an animated feature can play during the day but won’t attract paying customers at night, so a film for more mature audiences takes over the screen. In the past, Disney has requested certain animated films not be played after 8:00 pm.

Distributors generally dislike having their titles split because it theoretically leads to lower grosses. The adoption of digital projection technology has removed many of the physical and logistical barriers exhibitors once faced in booking more than one film on a screen. Operators no longer have to worry about moving heavy film prints between screens or reloading a platter with another print. It appears Disney would like to place a contractual obstacle in the way of theatre owners who wish to split screens showing their releases by limiting when it can be done.

Probably the most controversial clause raising exhibitor’s ire was one having to do with the percentage of box office that Disney was seeking for “Avengers” and other tentpole releases such as the upcoming “Tomorrowland”, “Ant-Man” and the highly anticipated “Star Wars: The Force Awakens”. If the WSJ is to be believed, Disney was asking for 60% of box office admissions. That is significantly higher than the 50% studios tend to pull in from what a cinema earns in ticket sales. Exhibitors keep the remaining 50%. But that figure is a rough average across all of a distributor’s releases. On one title a distributor may negotiate a 48% split, whereas on a bigger release it will require 52%. The average film rental across both titles would then be 50%. Getting exhibitors to pay a higher annual percentage on film rental by even a fraction of a percent could mean millions of dollars to a distributor, whereas the reverse is true for theatre owners.

Film rental accounting can be just as outrageous as the notoriously opaque methods used to calcuate a title’s final balance sheet for profit participants. There are well-established formulas and historic sets of terms that come with jargon such as “house allowance” and “minimum guarantee”. Over the last decade, descending 90/10 house allowance deals (in which the percentage of box office owed to the distributor declines in the later weeks of a run) fell out of favor in lieu of aggregate deals (wherein a set percentage is negotiated for all weeks a title is in an assigned theatre).

On a broad level, exhibitors license (or “book”) each title, film-by-film and theatre-by-theatre. This means different theatres owned by the same chain can have different film rental terms for the same release, though more often than not, a distributor applies the negotiated percentage across all screens circuit-wide. (That isn’t always true with larger chains, which place their theatres into various groupings for programming purposes). As a theatre sells tickets the film rental a cinema operator must pay to a distributor accrues at the aggregate rate agreed upon before the movie opens. An average of 21 days after a playdate week began, theatre operators will make on-account estimate payments to the distributor to pay off their film rental. These days payments are often made in-full, wiping out the contracted balance owed to a distributor, rather than estimated based on what he exhibitor might actually end up having to pay. In the latter case, a cinema owner will need to “settle” with a distributor, which is a fancy way of saying the exhibitor will haggle with the distributor over the final film rental percentage.

There are number of reasons for mutually agreed upon settlement payments. A film may have under-performed and a theatre owner may wish to renegotiate a lower box office split in their favor. Alternatively, a film may have over-performed and the distributor could demand a higher percentage of the gross. These two examples occur less frequently. Lately, many distributors have reverted to using an aggregate scale based on a title’s ultimate national box office gross; as a movie earns more within a territory the aggregate percentage paid in film rental goes up. For instance, a studio might negotiate a 51% aggregate across all weeks for one of their releases, against 53% at USD $100 million national gross or 54% at USD $200 million. Meaning if the movie earns USD $200 million nationwide, then the exhibitor will be charged a 54% aggregate film rental for every week they played the title.

This is one way Disney is estimated to be earning 60% of the theatrical box office gross for “Avengers: Age of Ultron”. When a hit release earns over USD $400 million in North America, as is predicted for “Avengers”, that aggregate scale film rental term can reach its own high record mark.

Disney was one of the first studios to migrate toward charging film rental based on an aggregate scale tied to national box office over the last decade. They were also one of the first to require film rental be calculated utilizing a “per cap” model. This technique assigns average ticket prices to a geographic region (a city, town, etc.) and then compares them to the admissions at a given cinema. If the per cap for an adult ticket in a region is USD $10 and an exhibitor reports having sold 20 adult tickets, then the gross receipts for these tickets should amount to USD $200. If the gross a cinema reports is less, say USD $150, than the exhibitor must make up the difference, (in our example that would be USD $50). This method was instituted by studios who grew frustrated over cinema chains deeply discounting tickets in an effort to draw more patrons and sell more concessions. In a per cap world, the decision to discount ticket prices has direct financial consequences for a cinema operator.

Each of these terms, the aggregate scale and the per cap, were designed to push film rental percentage levels higher for distributors, either directly or indirectly. In other words, studios employ them to lower the share of box office gross retained by an exhibitor. This is why when Disney tried to establish a per cap aligned with the average national movie ticket price, John Fithian, the chief executive officer of the National Association of Theatre Owners, says his organization received “an avalanche of complaints, confers and fears”.

According to the WSJ, NATO sent a letter to Disney expressing their members concerns with the new licensing agreement in which Fithian warns the proposed terms could lead to higher ticket prices and that, “a cycle of price increases may constitute illegal vertical price fixing under state and federal antitrust laws”. It is worth noting how uncharacteristic it is for Fithian and/or NATO to comment on licensing agreements or their members’ ticket prices. They generally steer far clear of such topics to avoid their own antitrust issues.

NATO does however regularly publish the national average movie ticket price for North America which is the figure Disney suggested using for its per cap calculations. The price is currently at USD $8.12, and though some of us living along the Atlantic and Pacific coastlines wonder how the amount could be so low, keep in mind this is an average price for the entire nation. Exhibitors with cinemas in areas of the country with lower ticket prices are anxious they may have to raise their ticket price just to meet the designated national per cap level. Another problem with using the NATO average movie ticket price statistic is the constant question over its accuracy and how it is derived.

The WSJ was told that Dave Hollis, executive vice president of distribution at Disney, fired off an email to Fithian that allegedly said the studio would negotiate terms directly with cinema operators and that “it wasn’t appropriate for the trade group to involve itself”. This would be the response one should expect, since indeed, NATO does not negotiate film rental terms on behalf of its members as that could tread into antitrust territory. On the other hand, it very well may be appropriate for NATO to raise its hand in the matter if only on the subject of their national average movie ticket price being considered for setting per cap film rental levels.

Disney could alleviate the unease over using the national average movie ticket price by simply returning to setting the per cap figure on a regional level. In North America the studio could create a per cap figure for each designated market area (DMA). Coming up with the average ticket price in each DMA may be possible by examining the box office reports coming in from exhibitors within the market. These reports contain ticket price information. Just a thought on a potential compromise.

Meanwhile, the kerfuffle over “Avengers: Age of Ultron” in Germany was brought to light by the publication Deutsche Welle on April 23rd, the day the film opened in that territory. Exhibitors representing 686 screens in 193 small towns (each with populations under 50,000) boycotted the title when, without warning, Disney raised the film rental fees for “Avengers” from 47.7% of ticket sales to 53%. Adding fuel to the fire was the studio’s plan to reduce their financial contributions toward advertising and to cut all funds for 3-D glasses.

It looks as if Disney may be trying to introduce terms in Germany that they have successfully enacted in other parts of the world. In North America co-op advertising fees have deteriorated significantly, and in some instances dried up completely. In other regions distributors have never paid for 3-D glasses, an expense studios have unsuccessfully attempted to get out of in North America as well. Moving to a set of terms that can be applied in all territories globally could make distributing titles much more efficient and easier, though one hurdle Disney will face in such an undertaking (besides angry exhibitors) is local government regulations pertaining to film programming, which can vary significantly from country-to-country.

One really can’t fault Disney for using 2015 as the year to pursue such a goal, for their slate of releases is absolutely stellar, as Disney’s chairman and CEO pointed out during the company’s earnings call:

“We have obviously, with our film strategy, created and will continue to create huge value for the theater owners here in the United States and around the world. And clearly, with the hand that we have got — Disney and Pixar and Marvel and Star Wars — our discussions in terms of the rates that we get paid, or the splits, have factored in the films that we release.”

Iger later emphasized the hundreds of millions of dollars it takes to create the films shown in movie theatres. Disney is thus using its strong slate of blockbusters as leverage in negotiating its master licensing agreement and film rental terms with exhibitors. Studios can’t however use one film to get better terms for a future release, or vice versa. At least not in the U.S. where such practices, known as “block booking”, are against the law. Still, by increasing their film rental percentages on “Avengers”, Disney stands a better chance of maintaining such terms for later releases, or at the very least, eventually convincing exhibitors to accept them.